Cal-Maine Foods: A Tale of Two Egg Shells?

Cal-Maine Foods (NASDAQ: CALM) is the largest shell egg producer in the United States and has been a short-sellers dream lately: the stock is down nearly 26% over the past year and short interest is at an all-time high. The catalyst for this decline, in a nutshell, is the expected price decline of eggs going into late 2016 as egg prices peaked earlier in the year due to the Avian flu creating a supply shortage. The market is expecting LOSSES due these price declines, as CALM is at the mercy of a fairly volatile commodity. Is this the beginning of the end for CALM, or is this an excellent opportunity for buyers? We believe it is the latter.

It is no secret that the egg market is an extremely cyclical business and is heavily tied to the forces of supply and demand, which are outside the control of any one producer. Although this would certainly hit CALM in the short-term, the company has had a history of creating value over very long periods of time despite volatility. History provides good insight into CALM’s operations: According to the company the: “demand trend related to the popular diets faded dramatically and (egg) prices fell” in late 2004, dropping the stock nearly 25% in 6 months. However, if one were to have bought CALM stock during this time and held until today, that particular investor would have made a return of over 520% (nearly 4x in less than 12 years) excluding the dividend (which currently yields over 6% per year). This is not to say that egg prices may not be perpetually depressed over the coming months or that CALM could be in for very long periods of egg deflation, but historically speaking, and this was recently seen with the price of oil, the harder a particular commodity falls, the more vicious it will rise especially if that commodity has favorable economic tail winds like the consumption of eggs.

Despite these macroeconomic variables, CALM is a solid operator of capital and has a history of creating value: the company has very little debt (has more cash than LTD) while providing investors with an ROE north of 28%. Operating margins are at a healthy 14% and the company has a FCF/Sales of over 15%. Despite the volatility of egg prices, CALM has an acquisition based strategy (it is a purely market share play) and revenue has increased nearly five fold over the past ten years with book value increasing nearly 6x over that same time span. Over its latest quarter, the company grew operating income by over 19%, revenue by nearly 3% while maintaining a P/E ratio of under 6 (which, quite frankly, does not make much sense). FCF over the trailing twelve months is at an all-time high, price to sales is at a paltry 1.0, and it has an extremely healthy payout ratio of 32%. Over 1/3 of the company’s market cap is in working capital, which is means that if this price decline continues, the company is looking at a Graham-esque valuation unseen by a consumer non-cyclical company.

Do we expect CALM to recover and the price of eggs to rebound?

Although we do not play in the futures markets, we do believe that CALM provides attractive value as the owner and operator of the largest egg brand in the U.S. (Egg Land’s Best) and history suggests that egg fundamentals will eventually stabilize given long-term demand trends for eggs. For investors who are patient and can stomach the wild swings, there are very few names that offer this level of value run by quality management. We’re expecting CALM price to fall near the $35, which would be an extremely attractive opportunity for the long-term investor.

DISCLAIMER: Logos LP is long CALM.