On the face of it at least, any investor should be able to understand this business. It produces eggs, perhaps even the ones you had for breakfast this morning. Eggs, by the billion.
Cal-Maine Foods Inc. (CALM, Financial) comes to our attention because of its presence on the Undervalued Predictable and Buffett-Munger screeners at GuruFocus. That means its price is below at least one major valuation metric, and it has consistently grown its earnings.
An appearance on that screener usually also means the share price has taken a tumble in the relatively recent past. This 10-year chart tells the tale:
So how does it happen that a supplier of a near-essential commodity finds itself in this situation, and does this pullback represent a good entry opportunity?
History
1957: Fred Adams starts a chicken farm in Jackson, Mississippi, and the following year launches a commercial layer operation in Mendenhall, Mississippi.
1963: The company builds what is then the world’s largest egg farm in Edwards, Mississippi.
1969: Adams Foods Incorporated merges with Dairy Fresh Products Company of California and Maine Egg Farms to create Cal-Maine Foods Inc. It supplies eggs across the country.
1996: Goes public on the NASDAQ exchange (symbol CALM).
2014: Reaches the milestone of selling more than 1 billion dozen eggs in one year.
2016: Announces it has signed a letter of intent to buy Foodonics International Inc. and related entities doing business as Dixie Egg Company. The deal also brings it the Egg-Land’s Best Inc. franchise.
Since 1989, the company has made 18 acquisitions, the largest of which involved 7.5 million layers (layers, as the name suggests, lay the eggs; pullets are females of less than 18 weeks, and breeders are males and females used to produce fertile eggs for reproduction).
History is based on information at the company website, except for the Foodonics acquisition announcement which comes from an Aug. 2Â press release.
Comments: A company that’s coming up to 60 years in a staple, commodity business; throughout its history it has had a growth strategy that included acquisitions.
Cal-Maine’s business
The company describes itself as “the largest producer and marketer of shell eggs in the U.S.” (Unless otherwise noted, all information cited comes from the company’s 10-K for the year ended May 28.)
Shell eggs are fresh eggs sold uncooked with the shells still on them. The other major categories are liquid eggs and frozen eggs.
Although all operational results are reported in one segment, Cal-Maine has two categories of business:
- Specialty: nutritionally enhanced, cage-free, organic, and brown eggs.
- Nonspecialty: all other eggs.
It is a mostly domestic business, and its main areas of market penetration are in the Southwestern, Southeastern, Midwestern and Mid-Atlantic regions of the U.S.
It operates what it calls an extensive distribution network that serves:
- National and regional grocery store chains.
- Club stores.
- Foodservice distributors.
- Egg product consumers.
A portion of its sales are made through co-pack arrangements, which involves outsourcing production and processing of certain products.
Its biggest customer in fiscal 2016 was Walmart (WMT, Financial), which took just over 25% of its production.
In recent years, the industry has seen increasing interest in specialty eggs (nutritionally enhanced, organic and brown); in addition, many of its major customers are looking for cage-free eggs, a market the company is pursuing.
The egg business generated $318,047,000 of net income in the fiscal year ended May 28.
The industry has enjoyed generally solid growth and expects consumer demand to keep growing. Every year since 2000, U.S. consumers have eaten between 249 and 263 eggs each; in 2015, that number dropped to 253 because of a shortage of supply brought on by an Avian influenza epidemic.
The epidemic also had an effect on wholesale prices, pushing them up from an average of $1.38 per dozen in fiscal years 2012 through 2015, to $1.79 in fiscal 2016, and then back down again. In the Fourth Quarter and Fiscal 2016 Results earnings release, Chairman and CEO Dolph Baker said,
“Throughout this fiscal year, our industry continued to deal with the aftermath of the Avian influenza outbreaks that occurred in the spring of 2015. While there have been no positive tests for AI at any of our locations, the outbreak significantly affected egg supplies and prices.”
He added,
“Our results for the fourth quarter reflect these extremely volatile egg market conditions and supply disruptions. Market prices for shell eggs have dropped considerably from the historically high levels we experienced at the beginning of this fiscal year. The Urner Barry price index hit a decade-low level during our fourth quarter before recovering a portion of these declines in recent weeks. In addition to the 21.7% drop in average selling prices over the same quarter last year, our sales for the fourth quarter reflect lower volumes, primarily related to the loss of a portion of a major customer’s co-pack business. While retail demand trends for shell eggs have been favorable, the market has continued to experience demand erosion for egg products and reduced egg exports. Based on USDA reports, the laying flock is expected to increase through the end of calendar 2016, creating more supply and the potential for further price declines.”
We also note that the cost of chicken feed figures prominently in the fortunes of the company. And prices of soy bean meal and corn have been volatile, as this chart from a presentation at the Stephens Investment Conference (June 7) shows:
Despite the turmoil of the last couple of years, the company summed up its position optimistically at the Stephens Investment Conference:
Comments: Cal-Maine has leveraged its size and resources to build the country’s biggest network of egg production and distribution to retailers. The pullback in the share price reflects the recent turmoil brought on by Avian influenza and feed prices, which affect all players in the industry.
Competition
Cal-Maine says of its industry, “The production, processing and distribution of shell eggs is an intensely competitive business, which traditionally has attracted large numbers of producers. Shell egg competition is generally based on price, service and product quality.”
The industry is quite fragmented –Â 56 different producers had 1 million or more layers. However, consolidation has reduced the field from 63 major producers in 2000. The company expects the continuing consolidation could reduce the cyclicality of prices.
Moat
Cal-Maine has size on its side; with an estimated 23% market share, it is the biggest producer and marketer of shell eggs in the country.
- It has a strong balance sheet with essentially no long-term debt (more to follow).
- A large, existing distribution system that handles deliveries to much of the U.S.
- Relationships with almost all of the major retailers.
Cal-Maine owns the trademarks to several established brand names: Farmhouse®, Rio Grande®, Sunups®, Sunny Meadow® and 4Grain®. It also produces and markets Egg-Land's Best® and Land O’ Lakes® branded eggs under license agreements.
Comments: Cal-Maine is the largest player in a fragmented market for a major commodity but holds its own because of its size, its financial muscle, its distribution capabilities, relationships with major retailers and several trademarked brand names.
Growth
In its 10-K, Cal-Maine says, “For many years, we have pursued a growth strategy focused on the acquisition of existing shell egg production and processing facilities, as well as the construction of new and more efficient facilities.”
As noted, the company made 18 acquisitions by the end of fiscal 2016 and since then has signed a letter of intent with another major producer.
Facilities: It has built a number of “in-line” production and processing facilities that allow for gathering, grading and packaging of eggs that use mechanical processes to reduce labor-intensity. At the same time, it has shut down older, less efficient facilities.
Adding volume and margin with specialty eggs, “In fiscal 2015, specialty shell eggs and co-pack specialty shell eggs represented 27.2% and 2.8% of our shell egg sales dollars, respectively, and accounted for approximately 19.8% and 2.0%, respectively, of our total shell egg volumes.” The company believes it can increase volume with these higher margin products.
At the Stephens Investment Conference, it laid out the specialty opportunity this way:
As for the overall egg market, this graph from the same conference presentation shows ongoing growth of demand:
Comments: Cal-Maine has an opportunity to maintain its growth by continuing with its proven acquisitions tactics, by developing new, more efficient facilities and by expanding into the growing market for specialty eggs and growing demand overall for egg products.
Other
Unusually, perhaps, among publicly listed companies, Cal-Maine has a variable dividend policy — it only pays dividends for quarters in which the company reports a profit, positive net income.
In addition, the policy also stipulates the dividend, whenever there is one, will be one-third that quarterly income.
Cal-Maine is headquartered in Jackson, Mississippi.
The company had a 2-for-1 stock split in October 2014.
At the end of the last fiscal year, on May 28, the company employed 3,277 persons.
Ownership
The Adams family and company insiders own almost 40% of the outstanding shares:
Turning to the other 60%, we see Chuck Royce (Trades, Portfolio) is the biggest holder among the investing gurus followed by GuruFocus, with 443,346 shares. John Hussman (Trades, Portfolio) holds the second-largest position among the gurus with 171,900 shares.
Turning to other owners, we see this summary from GuruFocus:
This image shows a solid buy-in on the part of institutional investors (mainly pension funds and mutual funds), as well as a high level of short interest. The latter suggests many in the market believe Cal-Maine share prices have not yet touched bottom.
And as we noted earlier, the 31% refers to just the holdings of the Adams family; other insiders own an additional 9.2% of the company.
Comments: The founding family and insiders continue to have faith in the company, and their interests are aligned with those of shareholders. Institutional investors seem to agree, but with such a large position by the shorts, we might expect more short-term share price volatility.
CALM by the Numbers
Comments: A mid-cap company with a low price-earnings (P/E) ratio and a high ROE; the share price is closer to the 52-week low than the 52-week high; float is relatively small because the founding family has a big holding; and the variable dividend policy has delivered almost 4%.
Financial strength
Lots of green and practically no red on this summary of financial strength, growth and profitability at GuruFocus:
The summary also shows us Cal-Maine has a Piotroski F-Score of 9, which is a perfect score by the nine criteria in that system.
Long-term debt at the end of fiscal 2016 was $9 million, which is to say practically no debt at all.
Despite the turmoil, revenue has continued to grow, as shown in this 10-year chart:
So, too, has EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization); again, a 10-year chart:
And this 10-year chart shows the growth of free cash flow:
Comments: Cal-Maine is essentially debt free, and its other metrics have shown solid progress despite the Avian Influenza and volatile feed prices.
Valuation
Cal-Maine enjoys a 4.5 (out of 5) star rating for financial predictability, in other words its ability to consistently increase its earnings. All else being equal, higher predictability means bigger capital gains, real or potential, after 10 years, and a lesser probability of losing money, according to a GuruFocus study).
The GuruFocus valuation system says, “Cal-Maine Foods Inc is more suitable for Earning Power Based valuation methods. This includes 1) Median P/S Value 2) Peter Lynch Fair Value. The Median P/S Value of Cal-Maine Foods Inc for today is 32.73. The Peter Lynch Fair Value of Cal-Maine Foods Inc for today is 163.25.” Not much of a consensus there.
The Discounted Cash Flow Valuation calculator gives us a valuation with a 36% margin of safety:
This five-year chart of its P/E suggests the share price is in bargain territory:
Finally, the PEG ratio sits at just 0.23, indicating the company is underpriced based on its earnings (a PEG ratio of less than 1.0 suggests the share price is undervalued; a ratio between 1.0 and 1.99 suggests the stock is fairly valued; and anything over 2.0 suggests overvaluation).
Comments: Given the consistency of earnings, I am inclined to look at the DCF valuation ($69.88) as the most logical target price. That is backed up to some extent by the P/E and PEG ratios; at the same time, though, I do not want to ignore the large number of short sellers in this name.
Conclusion
Cal-Maine Foods is a good company, available at a good price, thanks to recent turmoil in the industry.
It operates a relatively simple business although farming is always more complicated and more difficult than it seems from the outside. In addition, it is the biggest player in the industry and likely to get bigger through consolidation. At the same time, it is generating internal growth and taking advantage of the growing demand for eggs, particularly specialty eggs.
Cal-Maine is financially strong, with essentially no long-term debt, and good metrics for revenue, EBITDA, and free cash flow growth. It has the internal resources it needs to grow, including acquisitions.
The current price is a pullback from the trend, and longer-term investors interested in mid-caps should give Cal-Maine a close look.
Disclosure: I do not own shares in any of the companies listed here, nor do I expect to buy any in the foreseeable future.
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