Today's Buy Opportunity: Cal-Maine Foods

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Three weeks ago, I threw out a dozen, brand-new eggs thanks to the salmonella scare, which stinks because I almost never buy groceries. Oddly enough, although I couldn't eat the eggs, I will not be stopped from putting the Fool's money behind the very same company that sold those eggs: Cal-Maine Foods (Nasdaq: CALM  ) .

Eggs are truly boring business, and I typically don't cast an eye toward slow-growth, commoditized industries for new investment dollars. But if market outperformance is what gets your motor humming, check out Cal-Maine, a family-owned business that also happens to be the nation's largest producer, packager, and distributor of shelled eggs in the U.S. At today's prices, the stock looks truly eggs-cellent.

Terrible -- I know.

Fast facts on Cal-Maine

Market capitalization

$717 million

Industry

Eggs, eggs, eggs

Revenue (TTM)

$910 million

Earnings (TTM)

$67.8 million

Source: Capital IQ, a division of Standard & Poor's, and company filing.

Hmmm, salmonella
A serious contamination controversy might be reason to avoid a business like this, but that's a mistake. Unlike, say, plutonium-infused baby food from China, consumers aren't going to avoid eggs for all that long. I can't go more than a few days without a delicious breakfast sandwich or my girlfriend's chocolate chip cookies, and neither can a whole lot of Americans, which is precisely why I love this business.

The even better news is that the contaminated eggs that Cal-Maine sold (representing just 0.3% of that period's sales) were not really Cal-Maine's. Cal-Maine merely packaged them for the offending Iowa farm. I very much doubt that the company will face any significant liability issues. Thus, from both a demand perspective and a regulatory perspective, this recall is a big, old non-issue for Cal-Maine. Moving on...  

The incredible edible egg
Founded in 1969, Cal-Maine is a $715 million company whose positive attributes are simply too numerous to spell out in lyrical prose -- so please allow me to bullet them out:

  • Healthy balance sheet: Cal-Maine holds $200 million in cash against $135 million in debt and about $40 million worth of operating leases. This is a well-capitalized business.
  • Insider owned business with reasonable comp: Chairman/CEO Fred Adams Jr. has been at the helm since 1969 and owns about 35% of the company. Most of the executive team has been with the company for decades and collectively they own more than 40% of the company itself. Unlike Middleby (Nasdaq: MIDD  ) , a company with somewhat similar size characteristics, execs are very reasonably paid. (Incidentally, after only 5 minutes on the telephone with the good folks at Cal-Maine, I was able to arrange a chat with CFO Timothy Dawson. Accessible management is yet another hallmark of a shareholder-friendly business.)
  • Good capital allocator: Cal-Maine uses capital very efficiently. Returns on equity have averaged in the low 20s over the past few years, while returns on capital have been in the mid-teens. Enough said.
  • Cash-flow machine: Over the past 12 months, Cal-Maine pushed out just less than $100 million in free cash flow against $910 million in revenue. The company has plenty of similarly impressive periods of operating history.
  • Recession-protected product with strong distribution base: Eggs are eggs; the average person eats about 253 per year and should continue to do so. Cal-Maine owns about 18% of the total market. The overwhelming majority of these sales fall into the hands of the individual consumer via big chains like Wal-Mart, Sam's Club, Costco, and Food Lion, which means that the company isn't heavily reliant on the success of big chain restaurants, either.
  • Pricing power: Inflation concerns me. Fortunately, if grain prices shoot through the roof (chicken feed represents 60% of the company's farm production cost), Cal-Maine should be fine. It can raise prices, too. This is the nice part of being in a commodity business.
  • Robust dividend yield: At 3.9%, Cal-Maine's dividend yield is attractive. The dividend is fixed at 1/3 of net income, which might cause the actual distribution to bounce around a bit over time, but for the long term, I expect investors will love it.
  • Demonstrated success growing through acquisition: With long-term egg consumption expected to grow alongside our population (about 1% per year), Cal-Maine plans to grow earnings by buying up smaller operators and improving them using superior operational knowledge (50 years' worth). Cal-Maine has done it 16 times since 1989 with great success.
  • Potential secular growth thanks to sustained recession: This is just a nutty theory of mine, but if people get really poor, they might just trade-in their higher-grade proteins (beef, pork, etc.) for eggs. I know I did it in college.

Risks
Here's what might derail this small-cap juggernaut:

  • Decline in egg consumption: First, eggs were healthy, then they weren't, then they were, then they weren't, then they were. Back and forth it goes.
  • Failure to successfully integrate acquisitions: Growth through acquisition is a notoriously difficult strategy to nail. One bad purchase can ruin a year or two's worth of earnings.
  • Insider shenanigans: Any time one person (or family) owns a massive stake in a business, things can get very ugly for shareholders. We've seen it with Playboy (NYSE: PLA  ) and Value Line (Nasdaq: VALU  ) . Of course, it can also be a great thing, too -- see Berkshire Hathaway (NYSE: BRK-B  ) . I have a good feeling about the team at Cal-Maine, but I'll definitely be paying attention.
  • Backlash against Big Egg: Socially conscious consumers probably refuse to buy eggs from Cal-Maine. Fortunately, the company has prepared, venturing (quite successfully, I might add) into the specialty egg and cage-free segments under separate brands.

The numbers
Sophisticated stock valuation is a pseudo-science that I'm not particularly fond of. A few modest trading multiples next to a healthy balance sheet, proven cash flows, a promising future, and a solid competitive position is all I typically look for. On this basis, I'm happy to see that Cal-Maine is trading for a very reasonable 2.1 times tangible book value and a very cheap 6.8 times EV/FCF, which helps tell me this stock is ripe.

One technique I do enjoy using, however, is the reverse DCF, which helps me understand what the market is expecting as far as growth goes from Cal-Maine. Here's what I see:

Today's Price

2011 Growth

2012 Growth

2013 Growth

2014 Growth

2015 Growth

$30.00

5%

4%

4%

3%

3%

At $30 per share using a 12% discount rate, Wall Street is expecting Cal-Maine to grow too slowly. Over the past three years, for example, the company has grown profits by about 23% per year.

I believe Cal-Maine can do better, perhaps much better than the modest figures cited above -- which means, of course, that the stock is worth more than it is trading for today. How much more? I won't call out a specific figure. But, having just delivered 430% to shareholders since 2005 and with plenty of forward growth opportunity through intelligent expansion (not to mention the barrage of positive characteristics listed above), I absolutely think the stock is worth substantially more than $30 per share.

The Foolish bottom line
I like eggs. You like eggs. Perhaps it's time to take a look at one business that is positioning itself to dominate that larger space. The company has plenty of characteristics working in its advantage, shares are looking pretty darn cheap, and there's no reason to believe the company can't continue to reward shareholders. The Fool will be buying shares.

Previous recommendations:

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Fool Nick Kapur takes his eggs scrambled with cheese, sausage, and Frank's Hot Sauce. He owns no shares of any company mentioned above. Berkshire Hathaway is a Motley Fool Inside Value pick. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Read/Post Comments (11) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 13, 2010, at 12:53 PM, tgauchat wrote:

    I wish there were a way to support only the cage-free segment of this company and let the rest ... rot. Factory farms are despicable.

  • Report this Comment On September 13, 2010, at 2:47 PM, djbtudobem wrote:

    Hi Nick,

    Do you know what Cal-Maine's dividend policy is? It looks like their payout amounts have been all over the place the past few years. Thanks!

  • Report this Comment On September 13, 2010, at 3:55 PM, babusbuddy wrote:

    The egg industry is running an aggessive radio ad campaign in North Carolina. Hopefully, it will lead to greater consumption of eggs.

  • Report this Comment On September 14, 2010, at 2:22 AM, djbtudobem wrote:

    Tudo bem.

    Thanks!

  • Report this Comment On September 14, 2010, at 10:30 AM, valari25 wrote:

    No mention of the price fixing scandal and the ongoing class action lawsuit they are one of the major defendants in?

  • Report this Comment On September 14, 2010, at 11:56 AM, yeti23gh wrote:

    Decent summary of Cal-Maine. However, you are just plain wrong about their pricing ability. If grain prices go up, Cal-Maine's input costs go up, as you pointed out. However, this does NOT mean Cal-Maine can raise prices to compensate. The price they get for eggs is based on supply and demand, period. Even as the biggest player in the space they do not have pricing power. This is a common misconception in the egg business and agribusiness in general. If you grow corn and your cost of fertilizer goes up, you don't get to raise your price - you get what the market is paying. Think about the reverse; if your input costs went down, would you then charge less than market price? Of course not!

  • Report this Comment On September 15, 2010, at 4:37 PM, yeti23gh wrote:

    Good point - you are right about Cal-Maine's size being an advantage, because a rise in grain prices affects all producers. While it could hurt margins in the short term, it actually helps Cal-Maine out longer term, because it's size and healthy balance sheet allows it economies of scale over smaller producers. Cal-Maine has in fact used this advantage to aquire several financially weaker producers over the last few years, especially during period of overall egg market weakness.

  • Report this Comment On September 16, 2010, at 10:58 AM, anuj86 wrote:

    hi Nick

    thanks for the excellent article. But how often has CAL-M been able to pass on rising feed costs? how different is it in pricing flexibility to other (somewhat) similar plays likeTyson, Smithfield, etc? you mentioned that CAL-M has 18% market share and so benefits from its size. if am not wrong, SFD has over 25% share in Pork while TSN has more than 25% in chicken/broilers?i looked at these companies and found that they are often affected by factors beyond their control (corn, soy meal, etc) which makes their profitability very volatile and a bit unpredictable.

    so my question is how different is CAL-M from these 2 names? after all, even Pork and Chicken are items that Americans will consume whatever the state of the economy !

  • Report this Comment On September 17, 2010, at 12:41 PM, valari25 wrote:

    This isn't just your run of the mill litigation that companies have to deal with as a function of doing business. It isn't spilled hot coffee or ice on your sidewalk.

    It is price fixing, it is illegal and it is something undertaken with deliberate intent by management.

  • Report this Comment On September 18, 2010, at 4:25 PM, Glycomix wrote:

    Nick

    Good summary. Cal-Maine seems a bargain with a Price/Earnings of 10.2 and Free cash Flow number of 9.8. The difficult question here would be when to buy. I think it'll be a buy if and when its price rises above the $31/share resistance level.

    The chart was going down before July's positive news that CalMaine doubled it profit in the fourth quarter of 2009. What will happen when the 2010 first quarter numbers come out?

    Yeti23hg,

    Grain prices have less effect on eggs than meat. Even if egg prices go up, they won't go up as much as meat prices. Consequently, eggs look better as food purchases to families who don't have as much to spend. Thus when Cal-Main's volume goes up, so do its profits.

    On the other hand, I think that Berkshire-Hathaway-B (BRK-B) is a better buy. Its price has doubled in a year; didn't go down appreciably during the flash crash and it's P/E is the highest of all the stocks in the finviz.com universe with a PE of 0.01.

    It's Warrren Buffet's company, need I say more.

  • Report this Comment On September 20, 2010, at 10:15 PM, Netloss2 wrote:

    Price fixing litigation – One CALM competitor with about 11 million hens settled their portion of the claim for $25 million. CALM has about 28 million hens.

    From CALM 10k:

    >>Management determined that recent developments in the egg antitrust litigation have changed the likelihood of a material adverse outcome to reasonably possible.<<

    Supply – An industry expert has projected a significant increase in hen numbers over the next year, which may add to egg supply.

    California Prop 2 – When this legislation takes affect it could have a negative impact on industry hen numbers.

    Salmonella outbreak – Consumers may begin to demand more pasteurized eggs, which could add to input costs.

    Egg prices are currently stabilizing at very low levels after a big drop the last two weeks. Grain prices are on the rise. As a result CALM is not making a profit on the eggs being produced now. CALM is a good long term investment for the reasons mentioned, however, would like to see some of the above issues resolved before taking a position.

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