Shares of Cal-Maine Foods (CALM +0.46%) were far from calm on Sept. 30 after the company reported first-quarter results that were worse than already low expectations, causing the stock to dip back below the $40 mark in above-average volume. Sales at the country's largest producer of fresh shell eggs fell 29% to $241.2 million, marking a rough start to the company's new fiscal year. The $0.94 loss per share was deeper than the Factset's $0.85 analyst consensus, and it marked a dramatic swing from last year's $0.26-per-share profit. Consistent with Cal-Maine's dividend policy whereby shareholders receive a dividend only in profitable periods, no dividend was paid for the first quarter.
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Prices had a great fall
Sales volume actually rose by 1.7% in the quarter, as dozens of eggs sold increased to 254.4 million from 250 million in the first quarter last year. However, this was more than offset by a sharp 30% drop in the average selling price of conventional eggs, from $1.307 per dozen to $0.915. The lower prices were a reflection of oversupply conditions that have plagued the egg market since early 2018. Cal-Maine's results, while disappointing, were consistent with the weekly USDA Egg Market News Report of Sept. 23, which characterized recent market activity as "slow to moderate."
In its earnings release, Cal-Maine referenced the most recent USDA Chickens and Eggs Report that stated there were 331.4 million laying hens in the U.S. as of Sept. 1, almost a million more than last year. While the abundance of hens relates to more productive flocks and increased hatch rates, it is also a response to egg companies' recent pledges to move toward selling cage-free, organic, and nutritionally enhanced eggs. While this may lead to more humanely treated animals, the hen oversupply has only exacerbated the lowering of egg prices.
Feed costs remain elevated
Farm production costs per dozen increased 2.3% in the first quarter because of flock rotation and higher labor costs. Feed ingredient costs per dozen were relatively flat at $0.41, but these levels remain elevated in general because of historic rainfall and flood conditions that have led to higher grain prices. As U.S. farmers face a profitability squeeze because of of U.S.-China tariffs, the prices of corn, soybeans, and oats have been volatile, putting pressure on Cal-Maine's cost structure. Geopolitical pressures that affect feed grain pricing are likely to continue, according to management.
Walking on eggshells
Cal-Maine's specialty egg business -- think cage-free and organic -- accounted for 22% of overall sales volume in the first quarter, compared with 24% last year. That's because of the price differential between conventional eggs and specialty eggs. The price of the latter slipped only 1.4% from last year, to $1.86. But they're more than double the price of regular eggs, making consumers reluctant to scoop them up in great volume.
Although the specialty eggs segment makes up less than a quarter of Cal-Maine's sales volume, it represents an increasing portion of overall revenue at 45%, compared with 34% a year ago. As a result of the less volatile nature of specialty egg prices and rising demand for organic eggs, management is betting they'll benefit from a product mix that's skewed more favorably toward specialty eggs.
In response to promises by companies including McDonald's and WalMart, Cal-Maine's largest customer, to sell only cage-free eggs by 2025, the company is scrambling to prepare for a possible market shift. So far, the wide gap in price between conventional eggs and specialty eggs has meant consumers have been less willing to make the jump to specialty eggs. But as market dynamics improve, the demand for cage-free and other premium eggs is expected to drive long-term growth at Cal-Maine.
With pricing and feed cost out of its control, the company is forging ahead with plans to invest aggressively in its specialty egg business. "Our specialty egg business will continue to be a primary focus of our growth strategy in fiscal 2020," CEO Dolph Baker said. Part of the $45.8 million loss recorded in the first quarter was because of a $2.9 million impairment charge related to the decommissioning of older facilities as Cal-Maine continues to invest in newer, more efficient solutions to meet rising demand for specialty eggs.
Is this a boiling point?
Cal-Maine is hoping the specialty egg business can drive a return to profitability in the years to come. While the cage-free pledges of its customers are noble and the company's specialty-egg focus may be sound, in the end consumers still must be willing to pay up for the premium eggs.
Investing in a business unit that's experiencing sales-volume declines may pay off in the long run, but the economics are not currently in Cal-Maine's favor. Better market conditions must exist -- including dampened geopolitical risk, a significant reduction in supply, and a lower price gap between specialty and conventional eggs -- for the strategy to be successful. There will need to be signs of improvement at Cal-Maine before investors flock to its shares.
