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CAL-MAINE FOODS, INC.  (CALM)

Last Updated: Jul 4, 2008

Business Summary

Largest producer and marketer of shell eggs in the US (15.5% of total US consumption). Operating in 29 states, primarily across the southeast, southwest, midwest, and mid-Atlantic region. Cal-Maine holds the largest market share in the grocery segment, and markets to virtually all the major players. Also one of the largest makers of specialty eggs (cholesterol free, cage free, organic) - a rapidly growing segment representing about 15% of sales. Specialty egg brands are Egg-Land's Best and Farmhouse. Exclusive rights to Egg Land's Best in major metropolitan regions. Company is almost totally vertically implemented - they do everything from producing feed and raising chicks to packaging, distributing, and marketing the egg products.

Growth Strategy

Cal-Maine has been a consolidator in what is still a highly fragmented market (13 acquisitions since 1989), and plan to continue to take advantage of situations to consolidate. The point of these acquisitions are both to expand market share in existing markets, and to extend geographic reach. Eggs are not a growth market - about 1% growth per year, so the company has to gain market share or expand geographically to grow revenues. Company has and will continue to implement facility improvements to improve efficiency. Focused also on expanding specialty eggs, as they sell at higher prices and are less volatile.

Competitive Position

Cal-Maine is the largest egg company in the US, by far. This is a hugely fragmented industry, with over 60 competitors producing a meaningful volume. Cal-Maine looks to be a consolidator as it shrinks into fewer but stronger hands (which should also help to reduce price volatility and inefficient production volumes). Size, diversification, and financial means give it a meaningful advantage over the multitude of competition.

Risks

Cal-Maine is essentially a commodity company, and their profitability is directly influenced by wholesale egg prices. These have been rather high over the last couple of years, so that's something to consider (although the stock price reflects expectations of wholesale price drops). Feed prices are a primary cost component, and rises in corn and soybean meal affect profitability - although the company notes that historically, low feed prices led to overproduction of eggs and they are more profitable when feed prices are high. The growth strategy is acquisition based, which can always be risky. Customer concentration is high, with Wal-Mart/Sam's Club accounting for 37% of 2007 sales, and the top 10 customers accounting for 67% of sales.

Management

Fred Adams is CEO and Chairman, and he owns 36% of the common and 90% of the super-voting (10 votes) stock. Governance is somewhat questionable, as Adams is in complete control of the company - there will be no takeover or buyout without his approval. His son-in-law, Adolphus Baker, is President, CEO, and Director, and he owns the remaining super-voting shares. Adams is also the founder of the company in 1969 - he's 75 years old. Baker appears to be the heir apparent, he's 50 and with the company since 1986, a director since 1991. Compensation is reasonable, and the company grants few options.

Financial Health

Financial health is OK. The company has a net cash deficit, with about 88 million in cash vs. 104 million in debt. Trailing twelve month cash flow margin is excellent at nearly 13%, but this is due to historically high egg prices - the company only averages about a 4% FCF margin historically. The same goes for return on tangible capital, with historical levels well below current values. In an average year, Cal-Maine would not be considered an exceptionally attractive business, statistically speaking.

MagicDiligence Opinion

One thing to be careful of when following the Magic Formula is commodity stocks. Commodities have very volatile price swings and are heavily cyclical, in general. Unfortunately, the Magic Formula tends to turn these stocks up at the peak of the cycle, and throw them out at the bottom. This is the exact OPPOSITE of how to play a cyclical industry!

Eggs are an extremely cyclical commodity, and Cal-Maine's revenues are almost totally dependent on the wholesale egg price. Egg prices are currently at historical highs as rational pricing rules the day right now. But Cal-Maine is only 2 years removed from 2 straight years of net losses as egg prices were almost half of what they are today. In a normal year, the company's return on capital figures would not get it anywhere near the Magic Formula screen. Historically, commodity prices are boom and bust, and while Cal-Maine currently enjoys a boom period, we think the market is right to price in future weaknesses.

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