In October I pulled the trigger on adding a couple of new stocks to my portfolio. As always I framed my decisions by answering the 8 questions which I teach people how to answer in my Everyday Investing series of online courses. To give it justice, I will be breaking down my assessment into two separate posts. So let’s get to it!
Opened position in Cal MainE Foods (Ticker: CALM)
Q1: What do they sell?
Straight form the Reuters feed. Cal-Maine is the largest producer and marketer of shell eggs in the US. The company sells over 1 billion dozen shell eggs each year, or ~23% of US shell egg production. The Company operates through the segment of production, grading, packaging, marketing and distribution of shell eggs. It offers shell eggs, including specialty and non-specialty eggs. It classifies cage free, organic and brown eggs as specialty products. It classifies all other shell eggs as non-specialty products. The Company markets its specialty shell eggs under the brands, including Egg-Land's Best, Land O' Lakes, Farmhouse and 4-Grain. The Company, through Egg-Land's Best, Inc. (EB), produces, markets and distributes Egg-Land's Best and Land O' Lakes branded eggs. It markets cage-free eggs under its Farmhouse brand and distributes them throughout southeast and southwest regions of the United States. It markets organic, wholesome, cage-free, vegetarian and omega-3 eggs under its 4-Grain brand. It also produces, markets and distributes private label specialty shell eggs to customers.
Q2: Who do they compete with?
Cal Maine is pretty much a Goliath for egg production and distribution. There really aren’t many companies with similar scale and reach. The most significan competitors are Dean Foods and Tyson Foods. Most of its competitors are serve a local or regional market. CALM has grown quite a bit through acquisition.
Q3: Who buys their products and services?
Ultimately consumers are the final customer for eggs, but customers either go to the grocery store to purchase for home consumption or go to a restaurant for prepared products. Walmart is their largest customer accounting for more than 30 percent of sales. Restaurants and other food manufacturing companies are big bulk users for eggs.
Q4: Will they buy their product over and over again?
Eggs are staple food in Western cooking. It is a necessary binding agent in a variety of bakedand prepared foods. It is very much needed constantly. It definitely fits one of the core Investing Pillars.
Q5: Do they make money?
The company has been generating Returns on Invested Capital between 20 and 29 percent during 2014 and 2015. It’s cost of capital has tracked around 10 percent. As a result, it appears the company has been generated a very healthy level of Economic Profit.
Q6: What do they own and who do they owe money to?
The company is very liquid in that they have 5 times as much current assets than they do current liabilities. In fact they have enough cash they could pay their long term debt down and still have change left over. The company has very minimal debt (Debt/Equity =0.05). The balance sheet is very strong.
Q7: How risky is their business?
A big risk to the business is the health of its livestock. The Avian flu scare a few years ago severely hampered egg production as many chickens were culled to reduce the risk. Ironically it also created a shortage of eggs which benefited producers. CALM managed to weather the storm compared to other companies. The reality is outbreaks are can pop up anytime. On the flip side the industry can suffer from periods of over production which can damper egg prices. This appears to be the current situation as many egg producers have bounce back from the Avian episode and are producing much higher levels of eggs which has sharply reduced egg prices.
The recent National Shell Egg Index Price Report outlined several observations of the current egg market:
- Demand is light to moderate.
- Offerings and supplies are moderate to heavy.
- Market activity is slow to moderate.
- California delivered prices are lightly tested.
- The undertone is steady to mostly lower.
- Demand is light to moderate for the moderate to generally heavy offerings.
- Supplies are moderate.
- Market activity is slow.
Q8: Is the stock cheap?
The depressed egg market has had a negative impact on the companies recent earnings and stock price movement. The stock is down almost 19 percent year-to-date and 32 percent over the past 12 months. The stock was trading in the high $50’s and in October fell down to the mid $30’s. Recent earnings were not great. The company reported a quarterly loss citing falling egg prices and the stock got punished and that what got me interested. In terms of valuation, relative to other food companies, CALM is dirt cheap, trading at 6 times forward earnings compared to other firms which are trading in multiples of the high teens. From a discounted cash flow perspective, valuations put CALM stock in the $36-56 range. So there appears to be some meaningful upside to the stock.
I’ve had Cal Maine stock on my List of stocks I’ve wanted to buy for awhile. I never pulled the trigger because I thought the stock was just too expensive. To me this would classify as one of those ideal companies to invest in. It produces a product that is constantly in demand. It's not the most flashy company like a Tesla or Apple. It's actually a bit boring and boring in investing can be a very profitable relationship. It does one thing and it does it very well. Its operations are managed very efficiently and generates consistent wealth. It is a best of breed in its sector. Now with the industry in a down cycle, the stock has taken a hit and I thought this would bea great opportunity to start building a position. When's the best time to buy stocks low? Often it is when the business is in a down cycle but even in a down cycle it is still generating meaningful profits. At some point the pendulum will shift back and egg prices will track back up. I have no idea when, however, given the consistent demand for the product, it’s more a question of when than if. I'm happy to wait. Health scares are a wild card with food producers and you have to be mindful. Other factors to consider (courtesy Seeking Alpha):
- Egg prices will stabilize
- Current numbers are improving from the bottom
- People will continue to eat eggs until they die
- Restaurants are using higher quality eggs as consumers get smarter and demand better products
- Growth and sales from specialty eggs is increasing which CALM is heavily investing in
- Short ratio is high because traders use it as a hedge for their futures position. Not because there is something wrong fundamentally with CALM.
- Ramping up acquisitions and creating joint ventures for specialty egg to increase capacity and efficiency
I’m more comfortable with the current price point of $36-37 and based on valuations, there should be at least 20-30 percent upside over the medium term. If the stock continues to fall, I’m happy to average down.