Cal-Maine Foods: Get Out While You Can (NASDAQ:CALM)

Cal-Maine Foods (NASDAQ:CALM) is a great trading stock. It has been a horrible investment, however. Right now, shares are a little off highs in this market, but the company enjoyed a huge boost from rampant price inflation as well as favorable egg hatch data, impacted by some avian flu. It was a good combination for the company, and subsequently its performance. The thing is, these favorable conditions are going to subside. Inflation is being fought and hard. The avian flu issue has subsided. Input costs will remain elevated. Ultimately, we see egg pricing and earnings dropping off. This remains a trading stock, and we now have a short bias against it. The bottom line is that Cal-Maine stock moves with egg pricing and feed costs. Volumes of course matter for revenue, but it really is all about egg-pricing. We believe shares are sell here in the high $50’s. We are not buyers again until the stock roundtrips back to $40. Now, there is no guarantee this will occur, and we cannot predict what hatch rates or hen supply will look like, but we definitely do not want to own this as disinflation takes hold. An economic recession can also hurt demand, particularly if business demand slows. A weaker consumer, which is what the Fed wants, just is not good here. As such it is our belief that the stock is setting up for another run lower, and that the dividend, which is back, is likely to be reduced in coming quarters. Right now performance is great, but we see this performance falling next year.

Egg volumes

The company just reported earnings. The critical metrics that were aforementioned? Well, they led to a top and bottom line beat against consensus estimates. The top line was so strong, but is strongly associated with the price of eggs. The price drives a lot, but volume is a key driver of course. We suspect if you keep watching egg pricing and economic reports, which can greatly change egg pricing, you will see egg pricing trickle lower in coming months.

Egg demand has largely remained stable over the years, and is strong, and is for the commercial side is back to pre-pandemic levels in food service and of course personal/consumer trends remain great. We suspect demand stays relatively strong in 2023, though if we have a bad recession, commercial demand will fall, and consumer demand likely comes down a bit too. That would hurt.

That said, net sales in the just reported fiscal Q1 doubled from a year ago. IT was a new record, thanks to inflation in pricing and strong demand. Sales were $658.3 million, which were up 103% from last year. The increase in sales was a result of much better pricing, but there was actually a decrease in conventional egg volumes. However, there as record demand for specialty eggs. The company sold 275.3 million dozen eggs this quarter, rising from 254.6 million dozen last year. In the press release, CEO Dolph Baker stated:

We benefitted from higher average selling prices and record specialty egg sales volumes leading to historic Company record revenue for both conventional and specialty shell eggs.”

There was a big increase in pricing and favorable volume trends in specialty egg sales, along with efficient expense management, and this led to improved profitability with a gross profit margin of 33.0%. Another solid result which is underappreciated was that there was a noticeable increase in the amount of eggs sold relative to those produced, continuing strong trends on these differences. Demand outstripping supply, so to speak. Specialty eggs are generally higher margin sales, depending on sale price and the costs to produce them, and there was record demand. Despite the challenging environment globally with inflation and market fears, it was a benefit to the company. Sales of specialty eggs rose 35.1%. Further, a total of 31.8% of revenue was derived from specialty egg sales. This is a key driver for the company as these are much higher margin than conventional eggs, generally speaking. But not this quarter, because conventional pricing was so elevated.

So we mentioned how great pricing was. It was actually incredible. Conventional egg prices came in at $2.368 per dozen, up from $0.99 per dozen last year. More than double! That is incredible. Prices of specialty egg rose from $1.872 per dozen, to $2.101. Specialty egg prices are usually much higher than traditional eggs given the amount it costs to produce such eggs. But with food price inflation and avian flu, egg supply was impacted, and led to obscene pricing. Now, egg prices went up, but so did feed cost. When egg prices normalize, we do not see feed costs falling as dramatically, but do think they stabilize.

Feed costs

Feed costs are on the rise. As specialty eggs are making up more sales than conventional eggs we need to be aware that the feed costs here are generally higher than for conventional eggs. Inflation costs are starting to be reflected here. Feed costs are up huge in the last two years. In fiscal Q1 2022 costs hit $0.545 per dozen, versus $0.388 in Q1 2021. Now in Q1 2023, costs were up another 22%. It was also up from the last two sequential quarters and Dolph Baker has some concerns:

…We are pleased with our ability to manage the business despite significant inflationary pressures contributing to rising costs for feed, labor, packaging, and distribution, among other costs. We remain focused on the aspects of the business we can control.

Volumes drive revenues for sure, but with egg prices likely to be falling over the coming months, due to hen supply expected to normalize, we have concerns. While disinflation will definitely help lower feed costs, operating income will suffer as the egg selling prices come down. For now, it is party time, as times are good, but the party is quickly coming to a close. We recommend taking profit soon. The company saw an overall net income of $125 million, or $2.58 per share, in the quarter. This was a $0.02 beat vs. expectations. Given the higher sales of specialty eggs and the fact that conventional eggs were so expensive, we thought the beat would be higher, frankly. The feed and labor costs definitely weighed.

The dividend is back, for now

We want to remind you that Cal-Maine pays a so-called variable dividend. WE like this sustainable policy in our opinion. Basically, shareholders get paid a dividend when the company is net profitable on a cumulative basis. The dividend paid to shareholders is equal to one-third of quarterly income, but it looks at income on a cumulative basis. So any losses need to be made up before a dividend is paid. Well, as prices rose the last few quarters, earnings have been positive. As such, the company is paying a very nice $0.85 dividend this month.

Forward view

So why sell? Well, first, as mentioned, the Fed is pushing hard to weaken the economy. That is indisputable fact, and it could hurt demand. The avian influenza that hit this year that was first found in commercial flocks in the U.S. in February 2022 helped decrease supply and increase pricing. Right now, there is still some being detected in commercial flocks in the U.S. However, it is less prevalent and even management in the release guided on this stating:

…outbreak will continue to have an impact on the overall supply of eggs through the balance of this calendar year and possibly beyond. According to LEAP Market Analytics, layer hen inventory is not projected to exceed the 320 million mark until October of 2023.

So this tells us that the super high prices of eggs will start to reverse in coming months. We may have another quarter or two of nice strength, and a dividend, but we suspect the market starts to take this lower in coming months in anticipation of real normalization. Short sellers are making this bet, with short interest north of 15%. Traders are betting this stock comes down heavily. Take your profit.

Final thoughts

We have traded this stock so many times. While we usually take a long bias when the stock is under $40, we are compelled to have a sell rating here. The fact is that disinflation will hurt. A possible recession will hurt. By management’s own guide, the avian flu may last/impact things until the end of the year. It is nice to see the strong income, and nice dividend, but the party will come to an end into next year. Take profit while you can.