Notes from My Conversation with Cal-Maine CFO Tim Dawson

On Friday, I had the pleasure of speaking with Tim Dawson, CFO of Cal-Maine Foods (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

Comments

[Arsuron Pap...:]

Great information. I am approaching and becoming more cautious as stock approach $50. I do believe this stock deserve a P/E of much higher than 6 or 7, but historical profit level is concerning. The fact that he is looking to acquire more company pose another concern for me.

2008 Aug 12 09:11 AM

[SouthShore:]

According to your previous article you did NOT think CALM was worth adding to a portfolio. In case you thought no one would notice, here is what you said, ...

"Should You Put Your Eggs in Cal-Maine's Basket?
by: James Cullen
posted on: April 29, 2008

As [James Cullen] argued previously, [James Cullen] do[es]n't believe this is a good time to invest in egg producer Cal-Maine (CALM) because:

The business is highly seasonal
The business is highly cyclical
It is a commodity business allowing for no real competitive advantages"
---

However, in your current article (Aug 12th, 2008) you now state, "From the long pitch that led the BC Investment Club to purchase shares...". This appears contrary to your prior position.

In fact, your disclosure above says you have "No Position" in CALM. So if your are representing the BC Investment Club, then you should ethically disclose your actual position. If you are not speaking for them, then you should make that clear.

---

On April 18th and 29th, the dates of your previous two blogs on CALM, shares were selling for $30. That's when you said essentially - Don't buy, Don't buy.

Today's price is almost $44 and you could have collected at least the $0.516/sh dividend. That's about $14.5/sh on $30/sh invested.

I hope that your Prof's at BC aren't grading you on this stuff.

Cheers,
(Disclosure: Long until CALM tops)

2008 Aug 13 02:59 PM

[James Cullen:]

South Shore,
If you understood how the investment club I'm involved with functions, you'd realize I have to think beyond short-term trading moves. Running a portfolio democratically makes for different circumstances - trades need to be planned ahead of time and voted on, etc., and things grind to a halt for several months out of each year. CALM still makes me nervous because of factors like that.

Right now, I only own one company - Primus Guaranty - through both the common stock and senior debt. That blend has returned 75%, so I'm not too concerned about missing out on 50% in something I don't understand on nearly the same level.

2008 Aug 14 05:43 PM

[Derek Syphrett:]

Jim I am not sure I understood your answer to South Shore earlier. He asked you about CALM not about your returns at Primus Guaranty.

Also if Tim Dawson likes the CALM story so much why was he and several CALM insiders selling stock at an accelerated rate this month.

CALM insiders sold over $7M worth of stock in august only (1 month) vs. only about $4.5M for the prior 11 month period

I think Tim Dawson - Calmine CFO gave you a snow job son and your investment club is about to learn a few hard lessons about owning stocks with 80% short interests and CFO selling.


P.S.
I suppose that I should congratulate you on your 75% return on Primus Guaranty - though I'd have a hard time believing that anyone can understand an insurer (in this market) better than an egg company.

I know many money managers who've been confused by what these insurance companies are doing - it's great you made 75% with your play at primus... but don't get cocky... investors usually lose money right when they start bragging

2008 Aug 22 08:22 AM

[James Cullen:]

Derek,
Sorry if I wasn't quite clear. My comments on Primus relate to SouthShore's knock that I missed out on a big gain, and he hopes I'm not being graded on this.

To clarify things, the purchase of CALM was the result of a democratic vote by my school's investment club. I voted no; the majority voted yes. CALM was thus added to the portfolio, but I have no personal position in the stock.

Also, the pickup in the rate of insider selling isn't lost on me. Just because I relay what a company's management tells me, doesn't mean I necessarily agree that their optimism will be justified.

2008 Aug 23 12:49 AM

[TheFirst:]

Jim,

I am very confused. Mostly by the intent of your article and also by your less than persuasive ego driven replies that have followed here. As a student and as an investment journalist, I am not so sure I would research and publish articles that your ego and personal opinions make it impossible for you to stand behind or admit you were wrong about.

I understand that it is hard to be humble, but I better response to the first post would have been, "I was wrong in the short term and missed a 50% gain." Instead of, "I was more right somewhere else." The people that read this article are here for CALM advice.

2008 Aug 23 01:20 PM

[James Cullen:]

First,
I think you're splitting hairs, but sure - I was completely wrong about the direction CALM would trade in over the last four months. But does the stock price increasingput my concerns about the fundamentals driving Cal-Maine's business to rest? No.

2008 Aug 23 01:52 PM

[Derek Syphrett:]

Jim thanks for your gracious reply - in fact hats off to you in that your reply was much more gracious than my original post.

I think your investment club will be disappointed with their decision. Low PE's can be deceptive. Cyclical stocks peak with low PE's and bottom with high PE's.... beware of buying cyclicals with low PE's after they've had a good run.

I think the CFO actually gave you the best data point for selling CALM stock... the company trades at north of $40 per chicken and their competition will sell for $13 per chicken.... that gives you some idea of how overvalued CALM may actually be.

2008 Aug 26 05:47 PM

[James Cullen:]

Derek,
Not a problem - I thought your comments were constructive. I tried, unsuccessfully, to argue the various datapoints - cyclical stocks with low P/Es tend to be a bad idea, the price per chicken is skewed in the public/private market, etc., but that's only made me look quite wrong...

2008 Aug 28 12:10 AM