Avian Influenza: The New Norm?

| About: Cal-Maine Foods, (CALM)

Summary

Egg prices are soaring.

The latest bird flu outbreak is the largest in US history.

Let's evaluate winners and losers.

By Kris Rosemann

Source: Cal-Maine, Valuentum estimates; Urner-Barry Southeastern Regional Large Egg Market Price (per dozen eggs)

Egg prices are soaring as the avian flu has run rampant across farms in Midwestern states. According to some studies, the outbreak has reduced the national flock by more than 10%, and it is the largest outbreak on record in US history. Egg prices are the highest they've been in some time, and investors may not be fully aware of the implications.

A state of emergency has been declared in Iowa, where the impact may be the worst. Scientists believe the virus may recede as temperatures in the Midwest increase, but every company in the food products industry, big or small, is being impacted at the moment, and consumers have yet to see the full impact of the outbreak on prices. Retailers from Costco (NASDAQ:COST) to Walmart (NYSE:WMT) have been hesitant to share the effects in an attempt to avoid sticker shock by consumers. We find that the biggest "tsunami" that has ever hit the egg market has also been under-reported by the media.

Through the middle of May, egg prices increased nearly 60% since the month prior! The Midwest price of a dozen eggs reached ~$1.90 during the month. But that's just the beginning of the latest price surge. Data from the US Department of Agriculture is even more jaw-dropping. On June 8, the USDA said the combined regional average price for large eggs reached ~$2.43 per dozen. The red line in the chart below reveals the meteoric year-over-year increase in egg prices.

Image Source: USDA Egg Market News Report (pdf)

Some egg producers not based in the Midwest are picking up momentum. Cal-Maine (NASDAQ:CALM) continues to benefit on pricing as most of its flocks are not in areas impacted by the flu. On the other end of the spectrum is Hormel Foods (NYSE:HRL), which is feeling the pressure within its turkey supply chain. 55 of Hormel's farms have been affected, and management has warned investors of the potential for sales pressure in the back half of 2015. Tyson Foods (NYSE:TSN) may face some pressure with respect to leg quarter pricing, and Pilgrim's Pride (NYSE:PPC) has stepped up its efforts to prevent bird flu from spreading to its own flocks. Sanderson Farms (SAFM) believes the impact on the export markets is the primary risk with respect to avian influenza.

What's more, the outbreak may not go away soon, and the reach of the disease may actually be widening. Four farms in Arizona have been quarantined after receiving shipments of birds and eggs from farms in the Midwest known to be affected by the virus. The farms in question are not involved in commercial egg production, but the report is alarming. Southwestern US poultry producers have been on high alert. The states of Puebla and Guerrero in Mexico have also experienced outbreaks.

Total egg production for the year in the US is expected to fall nearly 5% from 2014 levels, and industry-wide expectations have been reduced by 87 million dozen. That the manner in which the ultra-contagious disease is spreading remains unknown to scientists is not encouraging. Even if rising temperatures slow the spread of the virus, participants within the egg supply chain will continue to feel the residual effects. We'll keep clucking as the situation develops.

Traders betting on a continued rise in egg prices may look to Cal-Maine as the prime beneficiary. The company's earnings in fiscal 2016 could have explosive upside potential. Our fair value estimate of shares, however, is only slightly higher than its $55 per share trading price. If the structural landscape of egg pricing has changed (in the case that the presence of avian influenza is the "new norm"), however, there's considerable upside to that estimate.

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.

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