Notes from My Conversation with Cal-Maine CFO Tim Dawson

| About: Cal-Maine Foods, (CALM)

On Friday, I had the pleasure of speaking with Tim Dawson, CFO of Cal-Maine Foods (NASDAQ:CALM). Cal-Maine is the country's largest producer of shell eggs, and the stock has recently broken out - sending the company past a $1 billion market cap for the first time. Despite the growing market value of the company and its acquisitive nature, there is still no Street coverage on it; Tim attributed this to the company's unique niche as a publicly traded non-packaged foods company, and partly to the fact that Cal-Maine handles all its acquisitions in house without the help of investment banks.

As Tim pointed out, CEO Fred Adams has nearly 50 years experience, and altogether, the executive team knows far more about the egg business than any Wall Street firm. From my perspective, no analyst coverage is a positive - it allows for more in the way of market inefficiency, and odds are any initiation will provide a boost to the stock.

I see the handful of major concerns an investor should have here as being some combination of the huge short interest, volatile egg prices, and a lack of visibility on the industry; Cal-Maine is the only publicly traded company in the space, so while it's the largest player in terms of sales at around 15% market share, there is a high level of fragmentation. Tim estimated the company's nearest competitors have a 12-13% share in the number two position, with number three around 8% before the market concentration drops off markedly.

With the number of possible acquisition targets out there, Cal-Maine certainly has the chance to continue its acquisitive past and add incremental share to its existing operations. The most recent deal was the $27 million acquisition of Zephyr, an egg franchise in Florida, which added 2 million laying hens to Cal-Maine's flock. The Zephyr purchase included other assets, but on a pure price-per-layer basis, Zephyr sold out for roughly $13/layer; whereas the price-per-layer assigned to Cal-Maine's layer flock (again, excluding all other assets), is over $40/layer.

When I asked Tim to explain this, he noted that Cal-Maine's scale and experience in the business allows it to extract more production from a layer, as well as having better distribution infrastructure to efficiently move the end product. My read is that he also implied Cal-Maine gets the better end of these deals, because the sellers tend to be looking to dispose of a family-owned asset for which there isn't really a market, and Fred Adams' long tenure and deep industry connections make them the first-thought-of suitor.

From the earnings press release, one of the only comments that could be of concern was Fred Adams' noting that slightly higher egg supply was slated to hit the market, but that this would be a manageable adjustment. Since higher supply in a very competitive commodity business is THE risk here, the extent to which higher supply actually comes on-line is very material; Tim's comments here were most helpful and also, in my opinion, explain the somewhat puzzling statement that Cal-Maine is more profitable in times of higher feed costs.

He said that the table egg layer flocks are down slightly year-over-year, likely because smaller operators are disposing of their older hens that are less efficient layers, and because of this the increase in pullets (which have a five month lead time from hatching to producing) is going to offset production declines, not increase supply on a net basis. Whereas the typical hen might have produced economically for 110 weeks previously, it is more likely that around 95 weeks the hen is not converting more costly feed into eggs at an acceptable rate for some products, though Tim said that Cal-Maine had not seen these kinds of problems and thus had not changed its production management techniques.

Because times have been so good and Cal-Maine has been highly profitable, it currently has $95 million in cash available; Tim said that the company would not be making material investments to bring new production on-line on a net basis - though the company does have a joint venture in the Midwest, a small specialty production facility, and the West Texas plant is meant to replace older production in New Mexico. Acquisition remains the preferred way to build the business, and will be made on an opportunistic basis.

And of course, I couldn't help but try to find some explanation for the short issue - with about 110% of the float short, naked shorting and possible failures to deliver have become a concern, though the potential for a short squeeze has made others more aggressive. From the long pitch that led the BC Investment Club to purchase shares, the potential for a short squeeze was one of the major selling points, though Tim suggested that the large short position may be due more to market makers in the company's options hedging their positions than anything else.

He stated that CALM has an extremely high open interest in the options that trade, relative to the float, and that certain exemptions the market makers have regarding short sales would let them carry such a large short position without onerous transaction costs. This idea is completely new to me, so I'm not sure what to make of it.

Disclosure: No positions