Cal-Maine Foods - An Egg-Ceptional Buying Opportunity

| About: Cal-Maine Foods, (CALM)
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Summary

Cal-Maine Foods, the leading fresh shell egg producer in the U.S., is hatching a plan while egg prices are at a low.

We see 40% upside as the market has punished Cal-Maine's shares due to depressed egg prices.

Cage free, organic and nutritionally enhanced eggs garner higher prices, and so should Cal-Maine.

Those who don't mind commodity risks should find egg-cellent risk reward ratio in Cal-Maine Foods.

Overview

Don't play chicken with this egg producer. While egg prices are well off of last year's average price of $1.79, and the Urner Barry price index recently hit a decade-low, Cal-Maine (NASDAQ:CALM) is well positioned for consumer trends, consolidation opportunities and to rebound from its 25% stock price pullback (from its 52-week high of $55.43). At KORR, we believe it is time to buy Cal-Maine Foods.

Cal-Maine is the leader in the industry with a total of 23% of the total market. The company continues to acquire competitors, having made 19 acquisitions since 1989, including the November 2, 2016, announced acquisition of the egg production assets of Foodonics International.

Soy bean meal and corn (feed) account for over 60% of costs. Prices of feed remain low and stable (averaged $0.43 per dozen eggs produced for the most recent quarter).

Regulatory and consumer preferences favor Cal-Maine, and provide pricing premiums for the specialty egg market. Specialty eggs currently account for 22.9% of Cal-Maine's total shell eggs sold and 46.7% of total revenues (most recent Q). The company's balance sheet, size, and business plan all favor CALM being a beneficiary of demands for cage free and other specialty egg demand, as capital costs associated with said shift present challenges for smaller and less financially capable producers. The industry will see more collaboration as evidenced by recently announced joint ventures between Cal-Maine with two large producers, Rose Acre Farms and Hickman's Egg Ranch. The joint ventures will increase Cal-Maine's specialty egg production and sales and are strategically located to certain markets.

The shell egg production industry has been and will continue to go through consolidation. We see Cal-Maine as a leader and winner.

Key Numbers (As of Q1, Q2 just came out last night)

Price: $43.25

Market Cap: $2.1B

EV: $1.82B

EV: EBITDA: 6.92

P/B: 2.37

P/E: 14.70

TTM EBITDA: $263M

LT Debt: $8M

Cash & CE: $307M

Current Ratio: 7.64

P/S: 1.35

POCF: 11.40

ROE: 16.19%

ROA: 12.59%

ROC: 41.77%

Rev Growth (3yr): 13.80%

EBITDA Growth (3yr): 66.80%

ROIC: 24.94%

Note: Cal-Maine's fiscal year end is May 28th (or end of May). Therefore, when we discuss last year, we are talking for the year ending May 28, 2016, which is referred to as 2016 by Cal-Maine. Current year is 2017, and CALM reported its second quarter last night (on 12/22) after the market closed. The reported losses were expected.

Macro

Last year the egg industry saw record prices for a dozen of Grade A eggs (avg. $1.79 per dozen), which exceeded 2015's record of $1.53. Record pricing was the result of an avian flu outbreak that caused a reduction of 12% in the national laying flock. Cal-Maine suffered no avian flu. In response to the high prices and reduction in hen laying flock, producers increased hen count to previous levels, and production increased, causing a glut in the market. Prices per dozen of large shell eggs dropped from an average of $1.79 to a current price of an estimated $0.86 per dozen, and $0.952 in the 13 weeks ended August 27, 2016. Specialty egg prices for CALM averaged $1.973 for the same period. Feed costs remain modest for the period, and we see them remaining so for the next year, absent any natural weather or disaster that disrupts corn and soybean meal supply. While the dollar remains strong, we see plenty of supply for feed (corn and soybean meal) in the U.S. and prices for the same remaining favorable.

Low, non-specialty egg prices will remain in the short term, but should see some seasonal improvements, although they may be modest. This price pressure will also lead to modest pricing pressure on specialty eggs.

Key Macro Takeaway From Last Night's CEO, Dolph Baker, Comments

"While the egg market has been in oversupply, recent USDA reports show the chick hatch has been down for three consecutive months over prior-year levels, so we expect to see a moderation in the size of the laying hen flock. Egg prices have also risen sharply since the end of our second quarter."

National retail chains and restaurant chains have announced a shift to un-caged eggs. Wal-Mart (NYSE:WMT), Sam's Club, Burger King and McDonald's (NYSE:MCD) are a few of the national chains that have publicly announced the transition to cage-free. In addition, California passed laws changing the type of eggs that are allowed to be sold in their state, and the way the hens are treated. Other states may follow their lead. Per Cal-Maine's recent 10-K filing below, this and the shift by large customers to cage-free eggs has a significant cost.

"California's Proposition 2 and Assembly Bill 1437 was effective January 1, 2015, and did increase the cost of production in that State and for producers who sell there. During our fiscal 2016 an increasing number of large restaurant chains, food service companies and grocery chains, including our largest customers, announced goals to transition to a cage-free egg supply chain by specified future dates. Changing our procedures and infrastructure to conform to these types of laws or anticipated customer demand for these types of guidelines has resulted and will continue to result in additional costs to our internal production of shell eggs, including capital and operating cost increases from housing and husbandry practices and modification of existing or construction of new facilities, and the increased cost for us to purchase shell eggs from our outside suppliers. While some of the increased costs have been passed on to our customers, we cannot provide assurance that we can continue to pass on these costs, or additional costs we will face, in the future." - (CALM 10-K '16)

Thesis

Buy CALM After Egg Prices Stabilize and Sell When Egg Prices Are At Highs

Consolidation and JVs will result in more stabilized egg prices.

Current low prices have caused heavy losses for egg producers. While it is true that these same producers experienced what should have been record last two years, if their flocks were not hurt by AI, we believe that the industry will accelerate its consolidation pattern and or move to joint ventures as the cost of switching production from non-specialty to specialty, including cage free, is substantial. Clearly, there will be winners and losers from this transition. Smaller producers will have a choice. Either they will sell, merge or join forces with larger firms, or they will be "fried." We see the large producers, especially Cal-Maine, benefiting from this change. While the overall benefits may take time to realize net profits, we see the time to invest in Cal-Maine and this transition as now and over the next few months. We do not see prices remaining at these low levels for a protracted period of time. Additionally, we note that while other egg producers are private companies, Michael Foods, which concentrates on processed eggs rather than shell eggs and has about 1/3 the amount of egg-laying hens (it buys additional egg supply from third parties), was purchased by Post Holdings (NYSE:POST) in 2014 for $2.4 billion or 25% more than the current EV of CALM.

About Cal-Maine

Cal-Maine is the largest producer and marketer of shell eggs in the United States. The company was founded in 1957 and went public in 1996. As a fully integrated egg producer, Cal-Maine's operations consist of feed mills, breeder flocks, hatcheries, pullet growing, egg production, processing, packaging and sales and distribution.

Cal-Maine is the largest producer of specialty eggs in the country. Specialty eggs include, cage free, brown, nutritionally enhanced, and organic. Pricing of specialty eggs is less volatile and is more expensive per dozen. There is a big push for cage-free eggs. Cal-Maine's specialty eggs section has grown from 14% to 22.9% of its sales since 2010.

Many producers are not prepared for this shift in preference to specialty eggs. Therefore, when prices drop to current levels, many cannot survive or weather the losses if their balance sheets are not solid. Cal-Maine uses times like these to expand and fulfill its acquisition plan. It continues to grow "organically" and through acquisitions.

The largest cost associated with egg production is feed. Feed consists of soy and corn. Prices of each have been favorable for the industry, and based upon crop plantings, and expected crop yields, prices should remain low (subject to extreme weather conditions). Additionally, we have seen pricing pressure on agriculture nutrients sold to farmers which should help their ability to maintain high yields. Low corn and soybean prices will help those companies that rely on corn and soy for their feed, including Cal-Maine, Sanderson Farms (NASDAQ:SAFM), Pilgrim's Pride (NYSE:PPC), and Tyson Foods (NYSE:TSN).

Conclusion

We think buying an initial position in CALM in the low-40s will result in 30-40% gains within 12 months. However, we would save some powder on the name, as we could see a pullback into the high 30s, and then we would buy a full position.

Disclosure: I am/we are long CALM.

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.

Additional disclosure: We may add to our position or sell our position without updating this blog.Readers should consult their own investment adviser and do their own due diligence.