Description

Cal-Maine Foods (calm $14.45; December 16th, 2004)

Cal-Maine is a Jackson Mississippi Company that produces, cleans, grades and sells fresh shell eggs in about 26 states. The stock has traded in a 52-week range $9.80-$22.80. Prior to 2003, the stock has never traded above $5! The enterprise value is about $362 million dollars. This equates to about $16+ TEV per chicken.

Earlier this year, I submitted this idea for membership to VIC. In the interim, doobadoo802 wisely recommended the stock as a short while the submission was under review. With a 45% bounce in the stock from the August lows on seasonal prices and a short squeeze, I think it is worth recommending shorting the stock or selling naked out of the money calls!

Industry Overview (source United Egg Aug. 2003 Fact Sheet)
The per capita-consumption measures the egg production divided by the population. Unfortunately, it does not measure demand. From the 2000 census figures, the 2002 per capita consumption is about 253.5 eggs per person versus 234.7 ten years ago. The high point was in 1945 at 402 eggs. The top ten egg producing states are as follows:
-Iowa {37,131}, Ohio {28,478}, Pennsylvania {22,729}, Indiana {21,970}, California {19,033}, Texas {14,017}, Nebraska {11,604}, Georgia {10,966}, Minnesota {10,460}, and Florida {10,205}.
The five largest states represent approximately 50% of the US layers. There are 65 companies that produce over 1 million layers and 9 companies that produce over 5 million. The industry has consolidated. In 1987 there were over 2,500 operations. Today, 90% of the production is
handled by 260 companies.

All the Fluff
Since there is no futures market, egg prices are volatile. Over the last eighteen months, eggs have been more volatile than any period for 30 years! Historically, eggs have averaged 60 cents a dozen! In November of 2003 and in March 2004 eggs touched $1.25 (wholesale egg prices x-CA) during the two strongest seasonal months. It is important to note that eggs trade at the highest price of the year at Thanksgiving and Easter (as recorded for the last 30 years according to industry sources)! From March (Easter), eggs traded back down to 49 cents at the end of October!

Therefore the last eighteen months, relative prices and yields are at historic highs. For the first time ever, the company made money for seven quarters in a row since coming public (vs. two consecutive quarters previously).

After this winning streak, the company lost 4 cents in the August quarter with an average price of 66 cents. For the November quarter, yet to be reported, prices averaged a mere 59 cents and due to historical low feed prices the total cost should be around 53 cents per dozen (43% of the 53 cents is feed) and should allow the company to earn about 8 cents in the quarter vs. $1.01 last year.

As mentioned earlier, Thanksgiving is a seasonal period. Therefore, the bulls are excited about seasonal trends in which USDA eggs prices have bounced back to $.75 (vs. $1.26 at this time last year during the seasonal trend). If prices held with the historical low feed cost, the company could earn 50 cents for the February quarter versus $1.23 last year. The only thing bullish x-seasonal prices is the lower feed cost. The historical total cost per dozen is in the mid 60 cent range.

As an indicator of future egg pricing, the pullets and breeders have been up 3-5% for the last 9 months according to the USDA, which should give a negative price picture for the next 6-12 months x-seasonal trends. In addition layers are up greater 4%!

Cal-Maine
Cal-Maine has an equity market cap of about $343 million dollars. In July of 2003, the company announced exploratory talks in taking the company private at $3.675 a share or a market cap of $75 million. In November 2003, the board bagged this proposal and the stock soared. The trailing sales per share are $24 and the book value is $5.65. Historically, the company has had a very erratic earnings history losing money 15 of the last 29 quarters. The company went public in December of 1996 at $3.50. The highest EPS was the following year at 60 cents. Fiscal 2004 was a banner year; the company reported EPS of $3.26. Yet, on the most recent quarter the company lost money and as usual the company refused to give guidance due to the volatility in egg and feed prices. Historically, this is a company that earns 5-15% on equity and trades for book. The next quarters could be positive, but common sense would lead one to ask if it is sustainable. There are little barriers to entry. With a cost of only $2.50 to produce a laying chicken, Wall Street in its infinite wisdom has valued these same chickens at a 9 multiple or $13+ per CALM’s bird. Recently, there has been a dramatic drop in feed, which may improve margins for a period of time. However, over the last 30 years lower feed prices have always brought on additional supply as it only takes five months to raise a laying chicken!

2004 Aberration
The bulls are excited the Atkins diet, the high short interest, etc. However, last years prices were an aberration never seen for the 30 years of the company’s existence. Buckeye Eggs (4% US production, 11 million layers) had to shut down last year due to EPA concerns. There was a delay before Ohio Fresh Eggs could get proper permitting when they purchased their largest facility. The other craze of the Atkins diet caused the “stars to be aligned” as Fred Adams the CEO said on CNBC! Now this morning, John Dorfman, Head Dorfman Investments, put it out on his annual stock pick! The last few years, one of his favorite year-end picks was another one of my shorts: Win Dixie!
I really question if he has done any research!

Bear Facts
This is a business with low barriers to entry. Industry surveys indicate that the producers are adding capacity. Also, feed costs have fallen. Soybeans have gone from $9 to $5.50 a bushel; while corn has gone from $5 to $2.20. Cheap feed levels have always encouraged farmers to bring on more supply. There are 259 other large chicken companies in the US. It is a matter of time when either they ramp production or raise capital to expand (ala looking at CALM’s enterprise value).

From the IPO in December of 1996 until the fall of 2003, the company’s stock never traded over $5 per share! Since the nirvana, there are more insiders’ sales than I care to count. In fact, the company distributed the majority of the stock in the ESOP to employees so they could sell. Eggs are the ultimate commodity business. The Indians were growing them in the US before Columbus arrived; this is the ultimate commodity business! In conclusion, I would sell stock short (or consider option strategy) now and add to the position on strength. Except for 2004, the stock appears to have traded below book ever year.

The target is $7 in twelve months, which is still 20% above book!


PS- Urner Barry’s pricing report released today has the following comment: “There was however a fairly broad range reported values causing us to widen our market spread.” The spread is to the downside. Lookout below Mr.Dorfman!

Catalyst

Wah came first, the chicken or the egg? Increased supply will lower egg prices and crush margins.