CALM - Cal-Maine Foods Generates Some Value-Play Profits

2024-01-05 00:56:21 ET

Summary

• Cal-Maine Foods is the largest US producer and distributor of eggs, commanding 21% of annual domestic consumption.
• The company has a strong financial position with a high current ratio and low debt/equity ratio.
• Risks for CALM include rising food costs and the potential threat of avian influenza, but the company is well-positioned to handle these challenges.

Americans love their eggs. I guess I always knew that, as one trip to a breakfast-centric diner shows a lot of eggs, hash browns, and toast being slung around. But the data suggests the average American eats 279, or more, eggs per year . So they don't just like eggs, they really, really like eggs.

Thinking about eggs, I'd like to take a look at Cal-Maine Foods (CALM). The Mississippi-based company is the granddaddy of all US egg producers, claiming 21% of the annual domestic consumption, and being the largest US producer and distributor of eggs in the shell.

Their business model is pretty straightforward. Feed goes into the chickens, and eggs come out. As of last June, per their 10-K, they commanded a flock of 41.2 million egg layers, and as demand grows they are forever breeding more.

By the Numbers

(source: most recent 10-Q from SEC)

As you can see, they have a good cash on hand and very few liabilities, current or otherwise. That puts the current ratio at 8.44 and a debt/equity of just 0.18. This shows a very, very financially strong company, and even if problems keep hitting the egg market, those assets should give Cal-Maine everything they need to weather most storms.

All that cash also gives Cal-Maine the leverage to buy some more. They say the 10-K that they expect industry consolidation going forward, and being the biggest fish in the pond, it would only make sense if they were involved in that in a strong way.

Risks

And there's no shortage of risks for Cal-Maine, or the egg industry in general.

For one, food costs are soaring in recent years. They use 2 million tons of food and produce 1.9 million tons, but that comes at an ever higher cost in corn and soybeans. The war in Ukraine has caused prices to escalate, and even in mid-Michigan, where I live, you see a lot of both being grown as farmers try to take advantage of higher prices and demand.

As you can see, demand for both corn and soybeans has positively soaring in recent years, to the detriment of those buying it. It's starting to settle back into pre-war levels though, so the higher production domestically must be paying real dividends. That's good news for the hungry hens.

Cal-Maine reports food costs varying in FY2023 (which ended in June) as being 55% to 63%. That's pretty high, but if prices start settling down for everyone else, Corn is $4.93, down 24% from just one year ago, and soybeans are $12.70, down almost 6% from last year. That's a good time to be in the egg industry.

As far as acquisitions go, Cal-Maine might choose cash deals with all the free cash flow they have. The company also warns, however, that they might use shares of common stock to get the deals done, which is necessarily dilutive to investors already involved.

The one threat that worries me most is highly pathogenic avian influenza. While not as huge a problem as it once was, an outbreak did hit Cal-Maine's Kansas facility last month, infecting 1.6% of the overall flock. Later they reported a loss of 3% of the total flock, again purely in Kansas.

Now Cal-Maine, understandably for their size, breeds a lot of chickens, and has a lot of pullets (young hens), so replacing the egg layers shouldn't be a huge long-term problem. So far none of their other facilities have been hit at all. The real danger if it starts, as that could threaten production, drive prices up, and force consumers to eat something else for their breakfast. Again, no sign of this actually happening, but it's a risk I'd keep an eye on.

There is also the matter of cage-free eggs. Ugly videos from some farms of the treatment of layers in cages have led several states to adopt or plan to adopt cage-free mandates. Ultimately this will cover 29% of the US population. Cal-Maine says they cost more to produce, but also sell for a fair bit more, and with cage-free sales already 20.1% for the company, they seem well on their way to being competitive in that regard.

The real question though is if higher-cost cage-free eggs are the only ones allowed in a state if this will price some customers out of the market. If so, it could temporarily hurt the bottom line, though it will likely be sorted out as they get used to the new market prices.

2023: An Exciting Year

(source: 10-K from SEC)

In 2023, Cal-Maine's sales went up, and far exceeded the rising costs. This led to a virtual doubling of the gross margins over the previous year, to a gaudy 38.7%. This also meant a big rise in net income, giving us a diluted EPS of $15.52, a roughly 3.5 PE ratio. That's not to say I expect that they continue in 2024, but it is something to celebrate.

Indeed, with the price of eggs dropping almost in half this year, the expectation is probably well down. Q2 earnings already showed a big drop year over year, 35¢ vs. $4.07, and while not wholly out of line with analyst expectations given the price, parts of the market are souring on Cal-Maine early. Average analyst estimates are $2.78 for FY2024, and after Q2 they could easily be revised downward. Still and all, lower costs should mean higher demand, never a bad thing if food costs keep going back in line.

(source 10-K from SEC)

Free cash flow also got a lot better in 2023, surprising considering the rising costs. This explains the large amount of cash on hand in the balance sheet above. Between that and a totally unused $250 million in revolving credit facilities, that gives Cal-Maine a lot of options going forward to deal with whatever opportunities present themselves in the acquisition market.

Conclusion

2023 is over, and even if the projections for 2024 mostly hold, the dividend yield per share will be dropping a lot necessarily. Still, a low-cost provider of eggs, and the market leader by far, it's hard to hate Cal-Maine.

Indeed, I dare say that a potential drop in prices after Q2 may ultimately present a buying opportunity if the market continues to sour on their shares, and I would be very tempted to get some holdings if I can do so at a low enough price. This is a purely long-term play, given the costs versus the price of eggs, but I don't think in the long run it'd be an investment to regret.

2024 may look more like 2022 than 2023, but 2023 showed clear potential in Cal-Maine. Potential I'd like to be in on.

For further details see: