Prepared by BAD BEAT lnvesting Senior Analyst Tara
One name that we have frequently traded both long and short is Cal-Maine Foods (CALM), the only play we dabble with in the egg space. We look for names beaten down perhaps more than they should be and take contrarian positions to catch rapid return trades. As we previously discussed with our members at BAD BEAT Investing, we recently thought CALM was an opportunity in the mid-$30s. The COVID-19 crisis caused some panic selling in March, but the stock has recovered all of those losses and then some following strong earnings and an outlook that was pretty decent. We maintain a $45 price target and think that you should remain long. In this column, we review the key metrics that you need to be aware of looking ahead.
Revenues fall as expected
Revenues are volatile in this name and fluctuate with the price of eggs. You need to watch egg pricing and related data with this name, and right now, the supply and demand balance is off, weighing a bit on pricing. For the most part, the price of eggs has suffered again, and this weighed on revenues. In terms of the virus, some demand erosion from restaurant closures has impacted eggs, but so far, it has not impacted operations.
Net sales in the present Q3 2020 were $345.6 million, falling 10.0% from last year. The rebound we saw from 2017 lows in egg pricing is gone, but pricing is variable, and that is why we watch demand and hen supply. In other words, the strength in revenues in fiscal 2018 was from stronger egg pricing (see below), while volumes have not had any real impact on revenues, mostly. In this quarter, the price of regular eggs was lower, while volumes were also about the same. The company sold 271.3 million dozen eggs this quarter, flat from 271.8 million dozen last year.
It remains true that specialty eggs are critical for the company’s growth, however, sales of specialty eggs fell. They are still about a quarter of volumes, while 35% of revenue was derived from their sales.
People need to eat, and egg demand will always be there. Changes in demand and pricing are everything here, and that is why the revenues fluctuate so much. Demand remains strong but eggs are oversupplied, and as such, pricing was lower.
Pricing
We would like to see volumes hold steady/increase very slightly, but revenues are driven mainly by pricing. Pricing was more favorable for specialty eggs but down heavily for regular eggs. Take a look, the net average price of a dozen of regular eggs is lower in the last few years, hitting $1.24 per dozen, down from $1.37 per dozen last year. We do note that pricing was up from Q2 2020, which was a net positive.
But compared to last year, the market has knocked pricing back again. Once the market starts to bid up egg prices again, CALM stock will move. There was jubilation after the report because it was revealed the virus really has not caused much disruption for the business, even through March. That was very bullish. That matters when we are looking for value and trades to make in this market. More broadly, Cal-Maine is basically an option play on the commodity that is eggs in many regards, but has lately traded like a defensive stock under the “people have to eat” mantra. Pressure is on right now for pricing overall.
We will remind you the USDA data shows export demand remains strong, as does domestic strength. This has been buttressed by more cage-free legislation for eggs, which, although it impacts the costs to do business, leads to a better selling price. As we have moved from 2017-2020, high demand trends had supported market prices, but we are now oversupplied. The chick hatch rate has risen. Hen numbers, according to the USDA Chickens and Eggs report, are 330.0 million, which is 11.8 million less hens than a year ago. That is bullish. For a long time, the increases in the number of hens continues to contribute to the oversupply of eggs – now we are moving the other way. Oh, and before anyone asks, we did our research and there are no known indications that COVID-19 affects hens or can be transferred through the food supply.
If pricing falls further, so will revenues and everything else down the balance sheet. Regular egg pricing is hurting. That said, specialty egg prices also fell versus last year to $1.89 per dozen from $1.95. Specialty egg prices remain higher than traditional eggs given the amount it costs to produce such eggs. The other part of the equation to watch is feed cost.
Feed costs surprise to the downside
The company is controlling what it can control. Overall, egg prices are beyond Cal-Maine’s control, but when it comes to factors impacting income, it does have some control over expenditures such as labor, packaging, shipping of the product, etc. Many of these items can be adjusted/controlled, but one key expense to watch which the company has less control over is feed costs. Feed costs remain comparatively low. Also, bear in mind that organic and other specialty egg production continues to grow, which requires a higher-priced feed formulation, and with egg prices falling, margins have been hit.
Gross margins are important to watch, but understanding their drivers (egg pricing and feed costs) can help you figure out if margins are likely to be strong. With what we are seeing, we predict margins will remain positive. We were thrilled that feed costs fell to $0.406 from $0.421 a year ago. This helped earnings.
Earnings positive
So we see what goes into revenues and costs, and while key metrics and the fundamentals that go into sales matter, we care about profits. That said, operating income was positive, improving from the sequential quarter which was a loss. Now, it was way down from a year ago, but that was mostly due to lower egg pricing. The feed cost decline helped drive operating income of $5.2 million.
Factoring in falling sales and overall expenses, net income declined versus last year. We saw a net gain of $13.8 million, or $0.28 per share, in the quarter, compared to a gain of $0.82 per share last year. It is not so much about this year versus last year that matters. We are looking at this on a sequential basis, and things are improving. Year to date the company has seen a loss of $0.87, and this needed to be made up before a dividend is paid.
The variable dividend
Cal-Maine pays a variable dividend. The approach preserves the balance sheet but can be frustrating for shareholders, as the company can go several consecutive quarters without paying.
Following each quarter for which the company reports positive net income, it pays a cash dividend to shareholders in an amount equal to one-third of such quarterly income. Following a quarter for which the company does not report net income, it will not pay a dividend with respect to that quarter or for a subsequent profitable quarter until it is profitable on a cumulative basis computed from the date of the last quarter for which a dividend was paid.
Therefore, Cal-Maine will not pay a dividend with respect to the third quarter of fiscal 2020, and will need to make up losses to get to a cumulative gain before a dividend is paid.
Our final thoughts on buying
We entered a contrarian position in the $30s, and the stock did overreact with market panic a few weeks ago. It has since regained all of those losses and then some. The stock just missed our price target of $45 after earnings. In the grand scheme of the present market, there is a lot to like here. Egg prices are improving a bit from last quarter. Feed costs are down. The demand trends remain solid – people need to eat. The hen supply is going down, and legislation that will drive more specialty egg sales is taking place. COVID-19 has not impacted operations, even in March. If you are holding the name in your account, we would stay with it.
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Disclosure: I am/we are long CALM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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