Cal - Maine Foods CALM S
October 08, 2007 - 2:42pm EST by
doobadoo802
2007 2008
Price: 28.40 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 665 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT
Borrow Cost: NA

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Description

Cal-Maine Foods (Short):“The kid is back on the escalator…” -Mall Rats.A long time favorite short of mine and bandit871, Cal-Maine foods is a well run egg producer, going thru yet another strong cycle.  However, eggs are a habitually cyclical commodity business, and Cal-Maine’s profitability will roll over and decline to at most historical levels within the next 6-9 mos as new capacity comes online.

Company Overview: Cal-Maine Foods is primarily engaged in the production, cleaning, grading and packaging of fresh shell eggs for sale to shell egg retailers. The Company had sales of approximately 700 million dozen shell eggs during the fiscal year ended May 31, 2007.  It primarily markets shell eggs in the southwestern, southeastern,  mid-western and mid-Atlantic regions of the United States. Shell eggs are sold directly by the Company primarily to national and regional supermarket chains. Thesis Overview:  Looking at an historic chart of the company’s share-price, you can see that it has had huge swings from $1.50/share in 2002
to run almost vertically to $18/share in early 2003, followed by a waterfall decline to $6/share in ’04 and ’05. 

It has once again had another near vertical run, and will once again decline back to a more reasonable valuation of $10-$12 share.  The most recent run is entirely due to a sudden spike in the ASP of eggs from their usual $.60-$.70/dozen to current $1.15-$1.20/ dozen.  Excluding feed, the cost of producing eggs is relatively fixed, which means that Cal-Maine’s operating margin went from the
low single digits to over 15% in the most recent quarter (and if pricing holds they will run over 20% for the current quarter).  Historically, operating margins in this business have been very volatile, but have averaged roughly 4% over the past 10 years. 
In addition, this average 4%, is made of hugely cyclical swings:  Over the past 40 quarters we’ve seen operating margins as
low as -12.5%, and as high as 20.3%.  On a rolling 4 q basis, margins have ranged from -8%, and 19.5%.  An impending return
o this normal margin implies a significantly lower share-price, even if the company continues to generate massive cash-flow for
a considerable period. Industry Background: Producing eggs is not rocket science and is a commodity business with low margins for the following reason:
-Eggs are fungible, there is no way to add a unique feature, or differentiate the product in any way that is not easily duplicable by other industry players.
-There are over 65 egg producers in the US, and although Cal-Maine Foods has 15% of US market-share they are far from a monopoly and the industry certainly isn’t an oligopoly by any stretch of the imagination-There is no proprietary technology, patents, or special know-how that adds significantly to production efficiency that is not
accessible to other industry participants
-No economies of scale/scope  (SGA/dozen does not decline as production capacity rises.  E.g. over the past
40 quarters Cal-Maine Food’s production capacity has about doubled by both organic and inorganic means, yet SGA/dozen shows no trend, remaining steady around its average of 8 cent/dozen.)  So in short, Cal-Maine doesn’t get any points for being big.Basically, there is nothing within the company’s control that can meaningfully boost ROIC for any meaningful period of time.

All egg producers are victims of the tides of fortunes driven by 2 factors: Market Price of Eggs, and Feed Prices. This brings us to the
determinants of egg spot prices: Supply and  Demand.Capacity and Demand:  The last big bull market in eggs occurred in the ’03-’04 time frame when producers were caught flat-footed as a result of the sudden popularity
of the ‘high protein’ Atkins and south beach diets.  In 2005, the industry put a substantial amount of new capacity online, flooding the market with fresh shell eggs and destroying pricing power.  Cal-Maine’s gross margins went to nil in the August quarter of 2005, and posted a negative operating margin of -12.5%:  The worst in the companies history.  The horrible pricing environment, combined with rising feed costs, caused growers to cut back dramatically on their flocks, reducing them to a 4 year low by the spring of 2007. This has once again created a tight supply situation. 

Demand has also picked up, due to the weak dollar increasing our exports of egg derivatives (most shell eggs are sold fresh, and therefore there is a minimal export component of only 3-4% of annual production).  So now you are no doubt wondering how long it will take for prices to come down?  It only takes about 3 weeks to hatch a new hen,
and 20 weeks for that hen to start laying eggs.  Growers have been reluctant to commit to expanding their flocks due to the bath they took in ’05, as well as corn and soy (the primary costs in raising a hen) are up 50%.    Because the national flock is still about 12 mil hens short of its previous peak, we know that production can grow a minimum of 3-4% before facility expansion is necessary.   Pullets hatched for egg production, has been running in the high single digits all summer, and they should be up and laying by early next year.  The only head wind is that we have a moderately old flock due to the dearth of hatchings in the ’06 time frame.

Fun with Graphs:The following graph is of the Hen Flock size, as well as the number of ‘egg type’ chicks hatched (according to the USDA).  As one can see, when hatchings exceed the 2 year average (green), the flock sized eventually expends (blue), and vice versa:  http://www.geocities.com/doobadoo1/layers.JPG

The following graph shows Cal-Maine Food’s Gross margins (green), relative to and inverse of the USDA’s flocks size lagged 6 months (blue, most recent 2 dots are my estimates based on hatchings): http://www.geocities.com/doobadoo1/margins.JPG

Valuation:   I use 2 methods for valuing Cal-Maine, a DCF and an historic EV/unit of production (a hen). For the DCF my assumptions are:
- 4.2% for terminal value’s EBIT margin (Over the past 40 quarters, Cal-Maine Foods EBIT margin has averaged 3.7%)
- 10% discount rate, with a 15x  terminal multiple on NOPAT
- Effective Taxes at 36%- FY08 Egg ASP’s at $1.20 cents/dozen then returning to the 4.2% EBIT margin for ’09 and beyond

Using all the above I get a TEV of ~320mil, minus net debt of $60 mil and divided by 23.6 mil share count= $11/share or about 40% of the current share price. For those of you who love stress testing variables, using normalized OMs from 3% to 7%, and terminal multiples on NOPAT from 12-22x we get valuations from $7.25 to $24 (all below current levels).  Or more realistically, OMs from 4 to 5% with term multiples from 14 to 18 yields valuations from $10 to $15/share.

Historic Enterprise Value/Unit of Production: Before 2004, this company has never traded for more than $0.54/dozen of annual egg production (in 2007 dollars).  The average is actually $0.42 (2007 dollars). Even during the Atkins spike of 2004 it never traded above. $0.90/dozen.  Today the company is trading for more than that, at $1.02/dozen egg of annual production capacity.  Again, nothing has fundamentally changed about this company except that egg prices are currently out of control due to a short flock. 
For a quick look at my spread sheet, which includes all the graphs and numbers, visit:
www.geocities.com/doobadoo1/calm.xls

Risks:
Growers don’t expand their flock to historic highs for a period of time because they are afraid of high grain prices, and day traders take the stock to $50/share.
Mark-to-Market Risk: Cal-Maine is have in very strong quarter and may earn $0.90-$1.30/share this quarter depending on egg and feed pricing which is highly volatile. 

 

Catalyst

Margins returning to more normal levels in early 2008, followed by the stock trading back to intrinsic value of $10 or forward book value of about $6-7/share.
    sort by    

    Description

    Cal-Maine Foods (Short):“The kid is back on the escalator…” -Mall Rats.A long time favorite short of mine and bandit871, Cal-Maine foods is a well run egg producer, going thru yet another strong cycle.  However, eggs are a habitually cyclical commodity business, and Cal-Maine’s profitability will roll over and decline to at most historical levels within the next 6-9 mos as new capacity comes online.

    Company Overview: Cal-Maine Foods is primarily engaged in the production, cleaning, grading and packaging of fresh shell eggs for sale to shell egg retailers. The Company had sales of approximately 700 million dozen shell eggs during the fiscal year ended May 31, 2007.  It primarily markets shell eggs in the southwestern, southeastern,  mid-western and mid-Atlantic regions of the United States. Shell eggs are sold directly by the Company primarily to national and regional supermarket chains. Thesis Overview:  Looking at an historic chart of the company’s share-price, you can see that it has had huge swings from $1.50/share in 2002
    to run almost vertically to $18/share in early 2003, followed by a waterfall decline to $6/share in ’04 and ’05. 

    It has once again had another near vertical run, and will once again decline back to a more reasonable valuation of $10-$12 share.  The most recent run is entirely due to a sudden spike in the ASP of eggs from their usual $.60-$.70/dozen to current $1.15-$1.20/ dozen.  Excluding feed, the cost of producing eggs is relatively fixed, which means that Cal-Maine’s operating margin went from the
    low single digits to over 15% in the most recent quarter (and if pricing holds they will run over 20% for the current quarter).  Historically, operating margins in this business have been very volatile, but have averaged roughly 4% over the past 10 years. 
    In addition, this average 4%, is made of hugely cyclical swings:  Over the past 40 quarters we’ve seen operating margins as
    low as -12.5%, and as high as 20.3%.  On a rolling 4 q basis, margins have ranged from -8%, and 19.5%.  An impending return
    o this normal margin implies a significantly lower share-price, even if the company continues to generate massive cash-flow for
    a considerable period. Industry Background: Producing eggs is not rocket science and is a commodity business with low margins for the following reason:
    -Eggs are fungible, there is no way to add a unique feature, or differentiate the product in any way that is not easily duplicable by other industry players.
    -There are over 65 egg producers in the US, and although Cal-Maine Foods has 15% of US market-share they are far from a monopoly and the industry certainly isn’t an oligopoly by any stretch of the imagination-There is no proprietary technology, patents, or special know-how that adds significantly to production efficiency that is not
    accessible to other industry participants
    -No economies of scale/scope  (SGA/dozen does not decline as production capacity rises.  E.g. over the past
    40 quarters Cal-Maine Food’s production capacity has about doubled by both organic and inorganic means, yet SGA/dozen shows no trend, remaining steady around its average of 8 cent/dozen.)  So in short, Cal-Maine doesn’t get any points for being big.Basically, there is nothing within the company’s control that can meaningfully boost ROIC for any meaningful period of time.

    All egg producers are victims of the tides of fortunes driven by 2 factors: Market Price of Eggs, and Feed Prices. This brings us to the
    determinants of egg spot prices: Supply and  Demand.Capacity and Demand:  The last big bull market in eggs occurred in the ’03-’04 time frame when producers were caught flat-footed as a result of the sudden popularity
    of the ‘high protein’ Atkins and south beach diets.  In 2005, the industry put a substantial amount of new capacity online, flooding the market with fresh shell eggs and destroying pricing power.  Cal-Maine’s gross margins went to nil in the August quarter of 2005, and posted a negative operating margin of -12.5%:  The worst in the companies history.  The horrible pricing environment, combined with rising feed costs, caused growers to cut back dramatically on their flocks, reducing them to a 4 year low by the spring of 2007. This has once again created a tight supply situation. 

    Demand has also picked up, due to the weak dollar increasing our exports of egg derivatives (most shell eggs are sold fresh, and therefore there is a minimal export component of only 3-4% of annual production).  So now you are no doubt wondering how long it will take for prices to come down?  It only takes about 3 weeks to hatch a new hen,
    and 20 weeks for that hen to start laying eggs.  Growers have been reluctant to commit to expanding their flocks due to the bath they took in ’05, as well as corn and soy (the primary costs in raising a hen) are up 50%.    Because the national flock is still about 12 mil hens short of its previous peak, we know that production can grow a minimum of 3-4% before facility expansion is necessary.   Pullets hatched for egg production, has been running in the high single digits all summer, and they should be up and laying by early next year.  The only head wind is that we have a moderately old flock due to the dearth of hatchings in the ’06 time frame.

    Fun with Graphs:The following graph is of the Hen Flock size, as well as the number of ‘egg type’ chicks hatched (according to the USDA).  As one can see, when hatchings exceed the 2 year average (green), the flock sized eventually expends (blue), and vice versa:  http://www.geocities.com/doobadoo1/layers.JPG

    The following graph shows Cal-Maine Food’s Gross margins (green), relative to and inverse of the USDA’s flocks size lagged 6 months (blue, most recent 2 dots are my estimates based on hatchings): http://www.geocities.com/doobadoo1/margins.JPG

    Valuation:   I use 2 methods for valuing Cal-Maine, a DCF and an historic EV/unit of production (a hen). For the DCF my assumptions are:
    - 4.2% for terminal value’s EBIT margin (Over the past 40 quarters, Cal-Maine Foods EBIT margin has averaged 3.7%)
    - 10% discount rate, with a 15x  terminal multiple on NOPAT
    - Effective Taxes at 36%- FY08 Egg ASP’s at $1.20 cents/dozen then returning to the 4.2% EBIT margin for ’09 and beyond

    Using all the above I get a TEV of ~320mil, minus net debt of $60 mil and divided by 23.6 mil share count= $11/share or about 40% of the current share price. For those of you who love stress testing variables, using normalized OMs from 3% to 7%, and terminal multiples on NOPAT from 12-22x we get valuations from $7.25 to $24 (all below current levels).  Or more realistically, OMs from 4 to 5% with term multiples from 14 to 18 yields valuations from $10 to $15/share.

    Historic Enterprise Value/Unit of Production: Before 2004, this company has never traded for more than $0.54/dozen of annual egg production (in 2007 dollars).  The average is actually $0.42 (2007 dollars). Even during the Atkins spike of 2004 it never traded above. $0.90/dozen.  Today the company is trading for more than that, at $1.02/dozen egg of annual production capacity.  Again, nothing has fundamentally changed about this company except that egg prices are currently out of control due to a short flock. 
    For a quick look at my spread sheet, which includes all the graphs and numbers, visit:
    www.geocities.com/doobadoo1/calm.xls

    Risks:
    Growers don’t expand their flock to historic highs for a period of time because they are afraid of high grain prices, and day traders take the stock to $50/share.
    Mark-to-Market Risk: Cal-Maine is have in very strong quarter and may earn $0.90-$1.30/share this quarter depending on egg and feed pricing which is highly volatile. 

     

    Catalyst

    Margins returning to more normal levels in early 2008, followed by the stock trading back to intrinsic value of $10 or forward book value of about $6-7/share.

    Messages


    SubjectNice graphs + question
    Entry10/08/2007 04:24 PM
    Memberedward965
    Loved the graphs and the idea.

    Question: While I'm sure supply of hens is what it's all about in this industry, as a matter of curiosity are there indications of using substitutes for eggs as prices increase?

    I did some quick math and figured that starches would be many times cheaper than eggs, but obviously there is the taste issue. Maybe doesn't matter in the private home where we're talking cents, but in a large-scale commercial operation?

    Thanks for sharing!

    SubjectEggs
    Entry10/08/2007 04:32 PM
    Memberdoobadoo802
    They say that eggs are the glue in cooking. As far as processed foods, with a single egg costing $0.10, would Entenmann's really risk toying withe pound-cake recipe???

    I don't think we'll see demand destruction from high prices, no does the thesis rely on it. Incremental export demand, however, does become a moot issue at these prices.

    Hope that helps...

    --

    SubjectOrganic and Cage Free Eggs
    Entry10/08/2007 05:27 PM
    Memberrii136
    Thanks for the idea.

    Do you have any sense of how much the margin increase has been due to sales of organic/cage free eggs? Are these higher margin products where their might be different economics at play?

    rii

    SubjectCage Free
    Entry10/09/2007 10:53 AM
    Memberdoobadoo802
    Cage free makes up ~8-9% of production and 15% of dollar sales.

    These eggs too are sold at an index to spot (urner barry), and thus the margin will fluctuate with that.

    Are the economics different? Not really, caging is an easy way to increase productivity and reduce costs. Raising birds free range is simply more costly (higher 'shrinkage', lower lay rate, more labor intensive) but requires less ongoing capital investment.

    So called specialty eggs were 11.4% of dollar rev in FY '06, and 11.2% of dollar volume in FY'07. The decline, is probably due to high prices of commodity eggs relative to a smaller % price increase in specialty (as feed is a lower component of specialty for the above reasons). But the category doesn't seem to be rapidly growing.

    And if so how do we get to sustainable 20% margins? or even 10%? in any reasonable period of time to justify this valuation.

    SubjectInsider sales
    Entry10/09/2007 10:54 AM
    Memberdoobadoo802
    More insider sales hitting the tape today, 30k or so from COO an a VP in finance.

    SubjectQuestions
    Entry10/09/2007 02:02 PM
    Membercompass868
    Great idea. I have 3 questions:
    1)I am not close to the overall farm economy but read of significant land price inflation and the related impact on feed costs. How does that factor into your analysis of EV/unit of production? Is your inflation factor of 3% large enough? I know CALM is not too land-intensive, but it does own 17,000 acres plus other facilities. Shouldn't the EV/unit of production increase significantly vs. late 1990s given opportunity costs of land usage? I realize this is likely accounted for in the large margin of safety but am curious for your thoughts.
    2) The CALM website notes that new industry standards regarding space per chicken put together by the United Egg Producers (+20% by 2008) combined with "more complex permitting" will slow supply increases. Thoughts?
    3) How big of a headwind is the aging flock? Do you have any data on flock age over time?

    Thanks.

    Compass868

    SubjectPuts?
    Entry10/09/2007 04:58 PM
    Membergocanucks97
    Thanks for a great (proven) idea.

    Given your expectation for a strong Q and traditionally weak pricing in calendar 1H, have you looked at May '08 Puts? The puts look pretty expensive and may not leave enough time, but getting squeezed by IBDers to $50 will not be fun either.


    SubjectEgg Price Resiliency / Yet Mor
    Entry10/20/2007 02:31 PM
    Memberclaude535
    Doobadoo82 -- Thanks for brining this great short idea to the forefront was again.

    In regards to the last posting's question on whether sustained high corn prices may have led to more controlled capacity growth in the industry, it may be instructive to look back at the 1972-73 "spiking" of egg prices which was driven by substantially the same (order of magnitude) inflation in prices of feed cost inputs. This period is instructive both because it was driven by a similar supply-side inflation in feed cost inputs and because, of the 9 spikes (defined as >20% annual inflation) in egg prices since the end of World War II, it is the only one in which egg price gains held for more than 18 months. In all other cases, preceding or subsequent declines over the +/- 2 years rendered average egg price inflation over the period comparable to general food inflation. A short piece from John Schnitker for the Brookings Institute gives a fairly comprehensive account of this period (Brookings Papers on Economic Activity, Vol. 1973, No. 2 (1973), pp. 498-507)(available on Jstor). While this period encountered similarly sustained inflation in corn and soybean prices, egg prices began to moderate substantially (roughly 6-months) prior to the leveling off of grain inflation -- suggesting that egg farmers eventually came to anticipate such inflation and , towards to end of the period, over-built. More importantly, the spread between egg prices and unit feed cost per dozen (the so-called "feed price margin") barely broke from its 30-40 cents/dz historical range -- peaking in early 1973 at around 45 cents. By contrast, feed price margin in CY Q306 appears to have been in the range of 65-70s -- higher than its been in any period for which I've found comparable egg and feed cost statistics. Simply put, in nominal terms, its never been better to be an egg producer and despite comparable periods of feed cost inflation, the current economic rents to egg producers appear unsustainable.

    Also, regarding the general notion that industry organization or infrastructure costs (e.g., UEP and its guidelines) have spurred a new collective rationalization, the general structure of the industry still doesn't support this. With over 60 large-scale producers (>1mm layers), capacity collusion does not seem plausible even assuming that smaller producers might face scaling issues given the tightening of industry standards related to laying houses (again, assuming compliance). We've spent considerable time looking at the infrastructure to find some bottleneck that could enforce collusion but have found nothing.

    For anyone not frequenting the USDA website, egg prices have already begun to moderate substantially from the peak levels observed in September ($1 versus $1.20), supporting the capacity expansion that Doobadoo82 forecasted based on hatchlings. Insiders selling continues at a rapid clip with the Company's President disposing of 17.5k shares this week alone and over 200k net sold insider share since June. Insiders shouldn't be the only sellers of this Company for long.


    Subjectcurrent egg price
    Entry01/15/2008 01:03 PM
    Memberjoe661
    I've nosed around the USDA site and found data for historical pricing but haven't been able to find current pricing for eggs. Could someone please give me the link for it? Thanks.

    Subjectre: where to get egg prices
    Entry01/17/2008 02:00 AM
    Memberdj927
    http://www.ams.usda.gov/poultry/mncs/stats.htm

    Subjectjust wanted an update
    Entry01/30/2008 03:16 AM
    Memberdj927
    It's been 4 months since your write-up just wondering if you wouldn't mind sharing your current outlook. Has anything changed or do you still think prices will start to come down materially in the next 2 to 5 months? Thanks for the idea!

    Subjectegg prices
    Entry02/12/2008 04:38 PM
    Memberfinn520
    Thanks for posting your model. I am looking to update it and having trouble trying to locate the correct egg prices.

    For your tab, "Hist Prices Received", from where exactly are you pulling those numbers?
    I clicked through the source link on the sheet: http://usda.mannlib.cornell.edu/usda/nass/AgriPric//2000s/2007/AgriPric-03-29-2007.pdf

    On page 22, I get $0.681 per dozen eggs for March 2007. This compares to $0.943 in your tab (row 45). The average for the quarter per the above link is $0.699 (March = $0.788, April = $0.627, May = $0.681).

    The numbers I find that match up more closely with yours and those from CALM’s filings are from the USDA Egg Market News Report, but I can’t find these numbers in a table format, only by individual 2x weekly pdf:
    http://www.ams.usda.gov/poultry/mncs/ShellEgg/USDAEGGMARKETNEWSREPORT.html

    I appreciate any help.
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