CALM - Beneath Its Shell Cal-Maine Foods Is An Overvalued Consumer Staples Company

2023-07-28 15:24:56 ET

Summary

• Cal-Maine Foods, the largest egg producer in the US, has been positively affected by volatility in egg prices due to avian flu, inflation, and new cage-free regulations.
• The company's fiscal Q3 2023 gross profit was $463m, a 500% increase from the previous year, due to favourable egg and corn prices. However, these results are not expected to repeat.
• My valuation models suggest that Cal-Maine Foods' stock is overvalued by as much as 130%, despite the company operating in a stable industry with steady demand.

Cal-Maine Foods (CALM) is the largest egg producer in the United States, accounting for roughly one fourth of annual egg consumption domestically. Most of the Jackson-headquartered company’s eggs are sold in all states of the United States but the north-western ones. It operates properties such as farms, processing plants, hatcheries, feed mills, warehouses, and offices in many states. The company was founded in 1957 and has a history of deriving growth through acquisitions of other egg farms.

Product Trends

Even though demand for eggs follow regular seasonal patterns as well as a slightly upwards long-term trend, egg prices have seen quite some volatility in the last 2 years.

This has been due to several factors: Avian flu/H5N1 virus, inflation, and even new cage-free regulations have all resulted in increased prices almost all at once, making a dozen eggs cost more than 5 USD in late 2022. Since then, a dozen eggs now cost 1.11 USD as inflation has cooled and avian flu risks persist. Nonetheless, with solid egg demand yet, I think there is good reason to think that Cal-Maine’s market will continue its slight growth trend although the last two years have been advantageous to Cal-Maine Foods’ bottom line.

Latest Financials

In general, gross profits are impacted positively by increasing egg prices and negatively by increasing corn prices. Gross profits for the fiscal year ended June 3, 2023 of 1,196,457 K USD reflect the favourable market dynamics in egg and corn markets, actually 3.54x larger than previous year’s gross profit of 337,059 K USD. This has resulted in a Net Income of 758,024 K USD, 5.7x larger Net Income than last year’s Net Income of 132,650. As can be seen in the chart above, as the market for eggs is not as favourable as it was, I think there is no reason to believe these results will result in the future.

Despite the external impacts on the egg market, I think Cal-Maine has been successful in keeping appropriate product inventory levels valued at 28,318 K USD which compared to last year’s value of 26,936 K USD is virtually unchanged. It has also reduced its number of egg-laying chickens from 42.2 M to 41.2 M thus reducing costs a little.

Cal-Maine Foods’s balance sheet does not have any debt and lots of assets, meaning the firm is well-equipped to expand through acquisitions, weather hard financial times, or even take on debt to return cash to shareholders through share buybacks or enlarged dividends. Conventional financial theory would predict that adding debt would improve the firm’s efficiency, but its last 10 years’ history of annual Return on Equity indicate otherwise, showing that good ROE’s can be achieved without debts:

Risks

In general, Cal-Maine Foods benefits from increasing egg prices and decreasing corn prices. Therefore, because of the interconnectedness of global grain markets, an external shock in one of these markets will harm Cal-Maine’s profitability. Since the Ukraine Grain Deal with Russia expired on July 17 ^th , wheat prices have been on an upwards trend again:

And corn has mirrored these price movements in wheat:

This poses a risk to the future profitability of Cal-Maine. But with its strong balance sheet, this should not hurt the company further, in my view.

Valuation

The company’s value can be derived effectively by projecting out the company’s future free cash flows, discounting, and summing them. As a base, I will use the 10-year average of the company’s free cash flow per share. This amounts to 1.21 USD. For the first scenario, I will use a growth rate of 4 % in the first 5 years and 2 % in the next 5-10 years as well as a terminal multiple of 15. This results in per-share valuation of 19.8 USD:

For a second scenario, I will use a 4-year average of the company’s free cash flow per share of 2.12 USD and keep the other assumptions constant. This results in a share price of 34.7 USD:

These valuation models suggest that the company’s stock is overvalued by as much as 130 %.

If, instead, valuation ratios such as the price-to-sales ratio is used, the company also has the second-largest ratio of 0.75 among its peers in its industry, Farm Products. The company Vital Farms Inc., another listed egg producer, has a price-to-sales ratio of 1.47 which, contrary to the DCF valuation, indicates valuation expansion potential.

Conclusion

As the largest egg producer in the United States, Cal-Maine Foods operates in a stable industry and will most probably continue to provide eggs given stable demand. Despite this, I think the company’s share price still reflects a continuation of the abnormally good earnings from the previous two years’ time, rendering the stock overvalued in DCF terms but not in relative terms. Also, with the expiration of the Ukraine grain deal, corn markets could prove a headwind to the firm’s profitability. With this in mind, I do not suggest buying the stock at current prices.

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