Cal-Maine Foods: Buy The Dip

| About: Cal-Maine Foods, (CALM)

Summary

Cal-Maine Foods had a terrible quarter as average egg prices declined 58% y/y.

Just like last year, prices are at abnormal levels (this time they are abnormally low). They will eventually recover.

Cal-Maine Foods offers a nice mix of yield and capital appreciation potential.

Cal-Maine Foods (NASDAQ:CALM) continued to slide after the company reported weak results for FQ1 that missed big on the top and bottom lines. Sales declined 60.7% y/y due to a 58% decrease in average selling prices, and EPS of -$0.64 missed by $0.31. The company reported a net loss of $143 million, compared to net income of $30.9 million in the same period last year. We think investors should considering buying CALM at these levels, even though egg prices will likely fall further in the next year. Egg prices will eventually rebound, and when they do, the stock will go higher.

CALM was never going to be able to replicate the performance of last year. Last year, bird flu broke out, which reduced flock sizes and constrained supply, causing egg prices to skyrocket to all-time highs. The company's flock was unaffected, which meant it was able to gain market share at the same time it benefited from higher egg prices. This resulted in a period of abnormally high profitability that was impossible to sustain. Fast-forward a year later and supply has now recovered, and it is expected to continue to increase. According to USDA Chickens and Eggs Reports, more chicks have hatched, and CALM expects the "national egg laying supply to continue to grow through 2016" before things possibly start to correct early next year. Valuing CALM based on P/E, P/S and P/CF ratios is meaningless, as both last year and the upcoming year represent periods of abnormally high and low profitability for the industry. What matters is that pricing will eventually rebound to more normalized levels, and when this happens, the stock price will rise in tandem (there is a strong correlation between CALM stock price and the price of eggs). As long as the company keeps volumes steady, which it has done historically, egg prices will continue to be the key driver of CALM stock price.

In addition to the inevitable recovery in egg prices, we are optimistic about CALM for a few reasons. The company has a strong balance sheet (D/E of 0.01) and a stable long-term outlook, thanks to healthy eating trends and rising demand for proteins. It will focus on making specialty eggs a greater portion of the sales mix, which should boost margins, all else being equal. The biggest threat to profitability, other than lower egg prices, is rising feed costs, which account for 65% of the company's costs. But there is still excess supply in the corn and soybean markets, which should keep prices low through 2017. Shares currently trade at the bottom of the 52-week range, and we think it makes sense to buy in now at a low cost base. At these prices, CALM's dividend yields 5.3% (compared to its 5-year average of 2.6%).

Conclusion

Egg prices can fluctuate wildly from year to year, and they will eventually recover. Armed with this knowledge, it makes sense to buy in now at a low cost base rather than attempt to time the absolute bottom in egg prices. Thanks to its industry-leading scale and low cost position, CALM will benefit more than its peers when prices rebound. The combination of yield and capital appreciation should result in a nice total return over the next year or two.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.