Cal-Maine Foods (CALM, Financial) is a financially sound small cap that is selling at more than a 35% discount based on the GF Value. This company is an industry leader in egg production, which is its single segment. The company generates a lot of cash, has very little debt, and GuruFocus gives the company a GF Financial Strength score of 10/10. Investing in this seemingly simple business seems to be a no-brainer, but there are a lot of moving parts to both the business and its economic environment.
Industry Characteristics
The company's financial performance is subject to wide earnings swings as confirmed by Cal-Maines quarterly operating income since 2020. Cal-Maines reported operating losses in the second quarter of 2020; the first, third, and fourth quarters of 2021; the first and second quarters of 2022; and most recently, the first quarter of 2024. The company also reported a net loss in FY 2021, mostly due to negatively impacted food service sales resulting from COVID-19 shutdowns of restaurants and other non-essential businesses. Cal-Maine Foods' Fiscal Year runs from June 1st to May 31st of each calendar year.
Sales and earnings fluctuations are caused by supply of inputs such as feed and packaging, production constraints, and customer demands and preferences. Production constraints are affected by outbreaks of avian flu (HPAI) and customer demand for conventional and cage-free eggs. Seasonality also affects demand, particularly the effect of the Easter selling season.
The egg production industry is highly fragmented and wholesale egg prices are extremely elastic. Gross margin as a percentage of revenue was 38% in 2023, a high-performance year, versus 13.3% in 2021. In FY 2023, egg production was limited due to US flock reductions caused by HPAI and the company was able to charge higher prices both for conventional and cage free eggs. More recently, egg prices have fallen as the effects of the last HPAI outbreak have dissipated and flock numbers are being replenished.
Cal-Maines vertical integration minimizes supply chain issues and production costs as compared to its competitors.
Examining Cal-Maine Food's Capital Allocation Structure
The family of Cal Maine Foods late founder maintains a controlling interest in the company. Family-owned businesses generally have a higher level of commitment to the company's long-term success and stability versus those controlled by outside interests who may be more focused on short-term performance to the detriment of long-term value.
The company makes a practice of retaining earnings for investment back in the business and to keep cash flow levels relatively high. Capital deployment is devoted to operations, pursuing business partnerships, acquisitions, and adapting existing facilities to meet changing consumer demand. The combination of high cash flows and low levels of debt help Cal Maines maintain a very low WACC to offset the impact of quarters in which the performance is negatively impacted by supply constraints and price elasticity.
Recent Acquisitions and Investments
Cal-Maine Foods has an acquisition-based strategy having made 23 company integrations since 1989. The business engages in acquisitions and franchise opportunities to expand their geographic market reach, to improve vertical integration, and to expand cage-free production. Management claims their long and vast experiences in these types of ventures have increased their integration efficiencies. The following are Cal-Maine Food's most recent acquisitions:
2019 - Texas-based Mayhard Egg Farm was acquired for an undisclosed amount to expand production and distribution in Texas and Oklahoma.
2021 - $18.5 million was invested in Meadowcreek to expand the egg products division and food service demand. Egg products comprised 4% of sales in FY 2023 versus 3% in FY 2021 prior to this investment.
2021 - $48.5 million was paid for a 50% remaining interest in Red River Valley Egg Farm from Rose Acre Farm to increase the company's Texas production of cage-free eggs.
2023- Fassio Egg Farms in Utah was purchased this year for an undisclosed amount that has been estimated to be between 54.1 and 67 million. The purchase consisted primarily of cage-free production facilities as well as other assets to assist in Cal-Maines' vertical integration strategy.
Cage-Free Egg Production
Cal Maine Foods has devoted nearly $700 million to Cage-free egg production since 2008. Cage-free egg production has been projected to grow nearly 6% annually until 2030, but this forecast appears uncertain.
According to Cagefreelaws.com, regulation has been passed to ban caged egg sales in 8 states and to ban caged egg production in 7 states.
By 2016, six out of 10 of Cal Maine's largest customers, including Walmart (WMT, Financial), HEB Grocery Company, and Publix (PUSH, Financial) which account for over 48% of sales, pledged to transition to cage-free egg supply by 2025. Many of these companies have revised their commitments to 2030 after the achievement of the transition appeared to be unobtainable.
The mix of specialty eggs (of which cage-free eggs are a significant component) to conventional egg sales raises questions. Cal Maines' specialty egg sales comprised 25% of volume and 39% of sales in FY 2019; 27% of volume and 38% of sales in FY 2022; and 35% of volume and 32% of sales in FY 2022.
Producing cage-free eggs results in higher food and biosecurity expenditures in addition to costs associated with building out facilities as hens have higher caloric needs and are more susceptible to disease resulting from their ability to move around the facilities. Similarly, injury and mortality rates are higher as uncaged flocks establish pecking orders.
Cal-Maine Foods will need more time to realize the value of these latest acquisitions and facility upgrade projects. Historically, Cal-Maine's capital allocation strategy has produced variable, but generally favorable results for the company.
Source: Author-generated chart based on GuruFocus data
In the above chart, book value adjusted ROE% is used instead of ROE% to help individuals judge whether the share price constitutes a good value. Averaging these ratios over the 5-year period from 2019 to 2023 produces a return on incremental invested capital (5-year ROIIC) that exceeds the working average cost of capital (WACC) by over 25%, a return on assets (ROA) of over 12% and a Book Value Adjusted ROE of over 9%.
Dividend & Buyback Policy
The company pays 1/3 of the income on a quarterly basis to shareholders and withholds dividends in quarters of unprofitability. This makes for a consistent payout ratio that does not cannibalize earnings in times of duress, yet it's variability is a deterrent to investors who rely on dividend yield.
Cal-Maines does not have a share buy-back policy and insider trades since 2019 reveal a pattern of share selloffs.
Take-Away's
Cal-Maines outstanding FY2023 makes this stock look like an outstanding buy at first glance. The company appeals to investors looking for a solid business with long-term value. In the near term, the return of egg prices to normalized levels may make this stock unappealing.
Both the business and the company's macroeconomic environment raise some concerns. Management has a history of good capital management to accommodate the industry's volatility, but investors may be weary given the company insider's refusal to snap up shares of this undervalued stock.
