CALM - Cal-Maine Foods: Eggflation Will Likely End Shorters Have To Cover

2023-05-05 11:40:38 ET

Summary

• Cal-Maine is the largest egg producer in the United States and has benefited greatly from increased egg prices.
• Increased feed costs and the bird flu outbreak caused prices to rise significantly, but analysts expect this trend to end within 1 to 2 years.
• Cal-Maine came in with strong sales and earnings growth of 109% and 717%.
• What I find especially attractive is their debt-free balance sheet and cash of $645 million.
• With a historically low valuation, I expect the share price to skyrocket. The catalyst is the purchase of about 16.5% of the float because of the high short interest of float.

Introduction

With the Fed continuing to raise interest rates and the banking sector posing significant risk to investors, the consumer non-durable goods sector seems to be doing quite well in times of recession. Cal-Maine Foods ( CALM ) is one such company that specializes in selling shell eggs. The company offers specialty eggs under various brands, such as nutritionally enhanced eggs, cage-free eggs, organic eggs and brown eggs. What I find particularly attractive about Cal-Maine Foods is that the company is debt-free, and the large amount of cash on its balance sheet is also nice.

Cal-Maine is a stock with high volatility, the stock price can show a strong uptrend, but the price can also stagnate at the same level for years. The stock is therefore only suitable for long-term investors.

Speculators would rather see the eggs cold than hot, as about 16.5% of the short float is short. This high percentage actually provides opportunities for long-term investors, because sooner or later these short sellers close their positions by buying the stock. Buying 16.5% of the stock can be a boost and I actually see this as a positive catalyst.

The Egg Market and Eggflation

Looking back over the past 80 years, Cal-Maine sees a trend driven by AHA and USDA publications. With a negative publication, volumes decrease, while with a positive publication, volumes increase. The USDA recommends eggs in a healthy diet for healthy individuals and this trend has been on the rise since 1990. Therefore, this egg consuming trend is expected to continue.

About 98% of households in the United States purchase shell eggs and egg products, making population growth one of the factors for the industry's growth projections. However, population growth is expected to decline in the coming years.

Another revenue determinant are egg prices. And like food prices, egg prices have skyrocketed. In the first quarter of this year, egg prices in the United States rose a whopping 155% from a year earlier. Some analysts are calling it eggflation . The rise goes along with the food index, but accelerated strongly after Russia's invasion of Ukraine. Analysts expect egg inflation to continue this year due to increased feed costs, the effects of bird flu outbreaks and regulations. Analysts expect the trend to end after 1 or 2 years, after which a price decline will occur:

The egg industry can generally count on the following rule: Price peaks tend to lead to similar price drops one to two years later. This is usually caused by producers' response to periods of higher margins. They typically increase hen numbers to try to tap into higher prices, thus creating oversupply.

Cal-Maine's Third Quarter Fiscal 2023 Earnings

The fiscal year ends in May and the recent third-quarter Fiscal 2023 results were strong. While Cal-Maine's conventional egg volumes are declining less rapidly than the overall market, the company has focused heavily on the fast-growing specialty egg products in which Cal-Maine is a fast-growing player.

The average net selling price per box of shell eggs increased from $1,605 in the third quarter of 2022 to $3,298 last quarter. The sharp increase in conventional egg prices brought net sales to $998 million, up a whopping 109%. Net income per diluted common share came to $6.62, up 717%.

Sales concentration is quite high: the largest customer accounts for 25% of total sales. The three largest customers account for 42% of total sales. Cal-Maine's customer base is of high quality with Walmart Inc / Sam's Club as one of the top 10 customers. The high sales concentration poses a risk, but the quality of the customers mitigates this risk.

However, analysts do not expect the sharply increased prices to continue and see a 31% drop in sales by 2024. Still, one may speak of significant growth, as sales reached $1.78 billion in fiscal 2022.

Dividends and share repurchases

What I find less attractive is the fluctuating dividend. The following chart illustrates the dividend's wild swings over the past decade. Currently, the dividend is a solid $8.80 per share, which represents a dividend yield of 18.5%. Note that the stock price will be adjusted for the amount of the dividend on dividend record dates. For fiscal year 2024, which begins in May next year, analysts expect a dividend of $1.41 per share (2.97% forward yield).

Cal-Maine Foods can easily carry the dividend because of its strong cash flows. Although the company pays a variable dividend, the strong cash flows provide cash on the balance sheet. Cal-Maine owns about $645 million in cash and has no debt. Thus, the balance sheet looks very strong.

Attractive Valuation

Usually I chart the stock's valuation by graphically displaying the P/E ratio or other valuation metrics related to earnings or free cash flow.

For Cal-Maine Foods, I chart the P/B because of fluctuating earnings and free cash flow. Several analysts expect lower earnings and sales for the next few years.

The P/B is at its lowest level in 10 years and is only 1.5, about 25% lower than the historical average. The stock appears cheap on this basis, but bear in mind that if the company posts a loss, its book value drops.

Over the past 10 years, 2017 appears to be the worst year with negative free cash flow of $113 million. Should this occur again in the near future, the book value drops by only 7.4% (current book value is $1,536 million). The price-to-book value will then quote 1.66, which is still attractively valued.

Conclusion

Cal-Maine is the largest egg producer in the United States and has benefited greatly from increased egg prices. Egg prices usually follow the food index, but after Russia's invasion of Ukraine, egg prices rose faster. Increased feed costs and the bird flu outbreak caused prices to rise significantly, but analysts expect this trend to end within 1 to 2 years, after which a price decline will occur. Cal-Maine came in with strong sales and earnings growth of 109% and 717%. And what I find especially attractive is their debt-free balance sheet and cash of $645 million. What I find less attractive is the varying dividends. Regardless of the lower earnings estimates, the valuation of the stock is very attractive when looking at book value. With a historically low valuation, I expect the share price to skyrocket. The catalyst is the purchase of about 16.5% of the float because of the high short interest of float.

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