CALM - Cal-Maine: Back To Reality

2023-10-04 13:35:26 ET

Summary

• Cal-Maine Foods, Inc. stock has retraced back to $43 after peaking over $60 due to the normalization of egg pricing.
• We called for a sell to start 2023.
• Feed costs are impacting margins while the company has made investments for the future.
• The variable dividend is a quagmire for income investors.
• Trade Cal-Maine Foods, Inc. stock.

After a massive surge in egg pricing in 2022, Cal-Maine Foods, Inc. (CALM) stock enjoyed an incredible bounce. We cautioned investors to sell the stock in December of 2022. While shares trickled a bit higher from that call, shares began to reset shortly into 2023.

The sell call was predicated on our belief that egg prices would normalize. That normalization has occurred, and shares have retraced back to $43, after peaking just over $60. With the normalization of pricing, moves to expand the business, a clean balance sheet , and a solid record, we believe this remains a solid trading stock. We move from a sell rating to neutral. Over the long term, CALM stock has been a horrible investment, but traders have done well, buying the big declines, and selling the rips that come from macro situations that send shares higher when egg prices spike. It is a quintessential buy low sell high type stock, and one that you can rinse and repeat.

When times are good there is a dividend, but when the company takes losses, the dividend is suspended until all losses are made up. It is a smart policy, but makes CALM a tough play for income investors. Thus, it is a "trader's paradise" type of stock.

For now, we think the stock will move sideways for a bit until we get the next move higher in egg prices. The just-reported earnings show strong volumes, but the impact of pricing pressure. Let us discuss.

Egg volumes

First, it is noteworthy that the company missed pretty handily on both the top and bottom lines relative to consensus estimates . The top line saw a dramatic drop-off and earnings were quite poor. Again, volumes are key, but egg pricing is largely what drives margins, along with expenses, most notably feed costs. Egg demand has largely remained stable over the years, and is currently considered in a moderate level by the USDA.

For the commercial side, demand remains strong as restaurants are still enjoying a steady flow of customers. When the price of eggs was so high it had weighed somewhat on consumer demand, and on the commercial side, prices increased on menu items. With normalization in pricing, the demand side should be stronger as we look ahead.

That said, net sales in the just-reported fiscal Q1 fell 30% from a year ago. Sales were $459 million. The decrease in sales was a result of the decline pricing, but there was actually an increase in conventional egg volumes, while specialty egg volumes declined. The company sold 273.1 million dozen eggs this quarter, dipping from 275.3 million dozen last year.

CEO Sherman Miller stated:

After reaching record high levels in fiscal 2023, average selling prices for shell eggs have since returned to more normalized levels as the overall egg supply recovers from the most recent highly pathogenic avian influenza ("HPAI") outbreak, which depleted the national hen supply. Customer demand has been favorable with conventional egg volumes higher than a year ago, offset by lower sales of specialty eggs .

That is a key statement, confirming our thesis to start 2023 that egg prices would fall off, and so would the stock. While there was some favorable impacts on the expense side of the equation, egg pricing crushed margins. Gross margin fell to just 9.9%.

Sales of specialty eggs fell 4% from a year ago. However, despite the volume moves, specialty pricing is higher, and that led to a total of 47.7% of revenue being generated from specialty egg sales. Conventional volumes were up about 1%. But the pricing really weighed. Conventional egg prices came in at $1.24 per dozen, down markedly from $2.37 per dozen last year. Prices of specialty eggs, however, actually rose from $2.10 per dozen, to $2.27 per dozen. Specialty egg prices are usually much higher than traditional eggs, given the amount it costs to produce such eggs.

We should note one bullish point is that the company has invested significant capital to acquire and construct cage-free facilities. The cage-free egg volume has continued to increase and account for a greater share of the company's product mix. Cage-free egg sales were about one-third of total net shell egg revenue in the quarter. We did note that feed costs also declined, which was a benefit.

Feed costs

Feed costs had been on the rise for a few years in a row. Feed costs are also generally higher for specialty and cage-free eggs. That said, feed costs impact margins greatly but we did see a decline from $0.667 per dozen to $0.597 per dozen. Of course, with the egg prices noted above, you can see the margin pressure. The company reported an operating loss of $6.8 million versus operating income of $163.9 million a year ago. However, the company is committed to cost management. For fiscal Q1, Cal-Maine Foods, Inc. saw an overall net income of $0.926 million, or $0.02 per share, missing estimates by a horrible $0.55. Now that the company is barely profitable, the dividend, which we talked about in the open, is now in jeopardy.

The variable dividend

Cal-Maine Foods, Inc. pays a so-called variable dividend. We are a fan of this policy overall from a cash management perspective, but it makes it unattractive to income investors. Essentially, if you hold the stock, you will get paid a dividend when the company is net profitable on a cumulative basis. The dividend paid to shareholders is equal to one-third of quarterly income, but it looks at income on a cumulative basis. So any losses need to be made up before a dividend is paid. Since there was slight net income, there was a $0.006 per share dividend declared. Depending on how pricing looks in fiscal Q2, if there are losses, the dividend will be gone until losses are recouped.

Final thoughts

Cal-Maine Foods, Inc. is a trading stock. It is not a good investment to buy and hold. We have traded CALM stock so many times here. We cautioned you to take profit as the party was coming to an end. We now have a neutral bias, and would look to go long if the stock dipped under $40, as this is generally a level where shares reflect low egg pricing, and we think it is where you buy and wait for the next catalyst for egg prices to rally. The decline in feed stock pricing is a positive, as are the investments Cal-Maine Foods, Inc. has made for future growth and product mix.

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