Cal-Maine Foods: Higher Prices Lead to Higher Profits

As gas prices continue going up, the debates are getting more emotional. About a month ago I had an interesting discussion or should I say argument about escalating gas prices. My “friend” adamantly put the blame on the oil companies. My argument about a few billion new entrants into the global economy creating supply/demand imbalances fell on deaf ears.

Regardless of the cause, there is absolutely nothing you or I can do about the price the oil. I have stopped worrying over things that are out of my control. I prefer looking for the opportunity in the crisis. The formula for investors is simple, increased revenue with fixed expenses generates out sized profits. Buying stock in such companies offset rising prices at the pump, grocery store or anywhere else.

Personally, I have made enough money trading Petrobras (PBR) to fill-up my car every week for the next couple of years. Petrobras, headquartered in Brazil, explores and produces oil and natural gas. In 2006, it produced on average 2.33 million BOE (barrels of equivalent) per day. The company has 11 refineries throughout Brazil, with a capacity of roughly 2.1 million barrels per day. It was ranked #86 in Fortune’s list of the world’s largest companies for 2006. An oil company with an emerging market kicker to boot - sounds like a winner.

I have made my peace with the oil companies, but chicken farmers - that’s a different story. According to wikipedia:

Chicken is one of the most used meats in the world. Nearly all parts of the bird can be used for food, and the meat is cooked in many different ways around the world. Popular chicken dishes include fried chicken, chicken soup, Buffalo wings, tandoori chicken, butter chicken, and chicken rice. Chicken is also a staple of fast food restaurants such as KFC, McDonald’s, and Burger King.

With chicken being such a key item in our diets, I would think that there would be outcries about escalating chicken prices. Over the past 3 months, Whole Grade A, Ready-to-Cook, Ice-packed, New York delivered chicken has increased 7.4% per data from the U.S. Department of Agriculture. That’s enough to make you want to ring a chicken’s neck, but it is more expensive dead than alive.

Eggs have not escaped the price increases. Large USDA Grade A, White eggs on New York store shelves have increased 4%. If you prefer your eggs in a liquid, non-pasteurized state, it will cost 7.1% more than 3 months ago.

Gas has been volatile, but it is only up 5% over the period in discussion.

Although chicken product prices have increased more than gas over the same period, I haven’t had one argument concerning the money grubbing chicken farmers. For whatever reason, chickens do not elicit the same uproar as oil.

One of the benefits of writing articles is that often readers send feedback. If you ever want a surge in email traffic – write a bearish article on gold. Gold bugs are quite an emotional group. A reader of one of my recent articles, Taking Eric Bolling’s Agriculture Stock Play, Making it My Own, sent an email stating that I should take a look at Cal-Maine Foods (CALM). The company is primarily engaged in the production, grading, packing and sale of fresh shell eggs.

If you have read any of my previous articles, you know that I one of my favorite strategies is to buy high quality stocks, participating in a theme of choice, that are making new closing highs. Lo and behold - CALM was screaming “buy me.”

The sentiment may be different between chickens and oil, but the fundamentals are the same. Higher prices lead to higher profits.

Comments

[matthewhanson]

This stock is destined to fall back down to Earth. I peg fair value at $10-$12. Egg prices move 8% on a 1% reduction in supply, and move 22% on a 2% reduction in supply. The fundamental demand drivers here are nonexistent: egg demand moves upward with population growth in the US, really 1% per year. Organic/cage-free/natu... eggs are still a tiny portion of the overall egg market. Europe and Japan are seeking small amounts of imports due to the cost of grain overseas, but now that corn and soy have moderated somewhat we will see the exports trail off. The long-term average USDA Grade A Large egg price has been wildly volatile from year to year. Look at CALM's stock price on the Atkins run-up in 2003-2004, then look at what happened to egg prices when the chicken farmers oversupplied just by a modest few percent--the price went down 35% in a matter of months, leading CALM to go from a huge profit in 2004 to bleeding losses in 2005 and 2006. This is a very low-margin commodity company that is trading at 3x book value right now. Unlike oil, which has a very fixed supply and huge capex needs, chickens and eggs are "renewed" in a matter of months, and the economics at these egg and corn prices will make a lot of farmers jump back in to the market, thus pushing supply way up and prices down. Model this as a perpetuity using long-term average egg prices and attendant margins and you'll be shocked at how investors can be valuing this stock at more than $10-$12. Respectfully submitted by Matthew Hanson of Twin Cedars Investments, LLC

[Marol]

Mr. Dawson: Please check out the comments on the "forum" -- can you answer my question about Calm falling now despite shorts, or suggest where I can find out more? Thanks!

[Marol]

Sorry. Forum's at
seekingalpha.com/symbo...

[Marol]

Actually, I see I have already mostly said this on my post on Apr. 14. But while I'm not an expert and you're probably right long term, from what I've read in the articles cited on Marketwatch (at CALM), they've got a ferocious penalty for shorts. Also, rules for cage space for chickens have changed, and much more room is now needed, so production won't ramp up for awhile. Egg prices up far more than 1/3 in the past year. (Worrisome. One of the cheapest proteins generally available, including in the US. People need to eat.)


On Jul 06 10:27 AM matthew hanson wrote:

> This stock is destined to fall back down to Earth. I peg fair value
> at $10-$12. Egg prices move 8% on a 1% reduction in supply, and
> move 22% on a 2% reduction in supply. The fundamental demand drivers
> here are nonexistent: egg demand moves upward with population growth
> in the US, really 1% per year. Organic/cage-free/natu... eggs are
> still a tiny portion of the overall egg market. Europe and Japan
> are seeking small amounts of imports due to the cost of grain overseas,
> but now that corn and soy have moderated somewhat we will see the
> exports trail off. The long-term average USDA Grade A Large egg
> price has been wildly volatile from year to year. Look at CALM's
> stock price on the Atkins run-up in 2003-2004, then look at what
> happened to egg prices when the chicken farmers oversupplied just
> by a modest few percent--the price went down 35% in a matter of months,
> leading CALM to go from a huge profit in 2004 to bleeding losses
> in 2005 and 2006. This is a very low-margin commodity company that
> is trading at 3x book value right now. Unlike oil, which has a very
> fixed supply and huge capex needs, chickens and eggs are "renewed"
> in a matter of months, and the economics at these egg and corn prices
> will make a lot of farmers jump back in to the market, thus pushing
> supply way up and prices down. Model this as a perpetuity using
> long-term average egg prices and attendant margins and you'll be
> shocked at how investors can be valuing this stock at more than $10-$12.
> Respectfully submitted by Matthew Hanson of Twin Cedars Investments,
> LLC