eggxtraordinary? Cal-Maine Food edition.

It’s been a long summer.  No analysis, no investment but a rocky september.  I’ve liquidated a long investment of mine, Jewett-Cameron, due to a big run-up in price.  I’ve now freed cash (30% of portfolio) and need to get back in hunting mode!  Here’s my first prey of the season.  Should I hit?

Description

Company

Cal-Maine Foods (CALM) primarily produces fresh eggs. The company makes shell eggs, liquid egg whites, sugar yolk, salt yolk, and dried whole eggs that it markets primarily to supermarkets, food-processing companies, and wholesale distributors in the United States. Cal-Maine Foods also produces eggs that do not increase serum cholesterol levels. In addition, the company operates a dairy facility that produces milk. Cal-Maine operates farms, processing plants, hatcheries, feed mills, and warehouses.

Rarely have I seen this in public company but Cal-Maine Foods introduced a flexible dividend policy and now distribute dividend amount based on net income.  It actually distribute one-third of net income to shareholders every quarters.  If the net-income becomes negative, CALM stops paying any dividend.  The dividend policy gives place to reinvestment and acquisition (2/3) and CALM is also active in this domain. At first glance, I like it.  But why would a small-cap company install such a dividend instead of growing?  Usually it is in link with management and insider ownership.  Is it this time?

Management

Adolphus B. Baker (President and CEO) and Fred R. Adams (Chairman Emeritus)  are members of the board and have 67.4% of the voting power(14.2% and 53.2% respectively) and have an ownership of 30% of the common stock.  What are the compensation vote?  Are they in line with the other shareholder or did the two directors voted themselves major compensations?

 
Chairman Emeritus
President/CEO
VP/CFO
VP/Egg Products
VP/Sales
Total
Salary 250 303 223 154 130
1060
Bonus 251 310 220 107 137
1025
Stock option 0 0 0 0 0
0
All others (Car, Country club, Life Insurance, Medical, KSOP)
227 86 71 49 34
467
Total
728 699 514 310 301
2552

Shareholders

Without being overly important, many funds are shareholders of CALM.  Some big names have millions in this investment including Vanguard group, Black Rock and Dimensional.  The biggest fund investment is Royce & Associates, a fund I personally do not know but which sells itself with the killing line: ‘Small-cap value investing is our core business’.

Financials

Balance sheet

The assets in CALM balance sheet presents 261 M in cash or 26% of the market capitalisation or CALM.  The rest of the current assets (excluding cash) are netted by total liabilities and we get a 50M cash required to cover all liabilities.  We may calculate the ratio removing 20% of the market cap to exclude cash.  Fixed assets are mostly composed of real hard assets (farms, lands, tractors, etc.)  There also is some goodwill represented on the balance sheet due to previous acquisitions (20M). Nothing to make you feel uncomfortable with the fixed assets.  The market cap is around 2 times the book value.

The company owns over 19900 acres of land across united states.  They also have 3 breeding facilities, two hatcheries, for wholesale distribution centers, 19 feed mills, 36 shell egg production facilities, 26 pullets growing facilities, 34 processing and packing facilities.  They invested 123 million dollars in automated in-line facilities that can now process, clean and package shell eggs without any human intervention allowing them to be the low-cost producer in every market.

Revenues

Profitability have been consistent over the years.  The previous 5 years were profitable (including recession) but profit dropped 50% in 2008 and is only starting to get back to previous levels.  The average 5 years is very close to the TTM.  In 2008, the company made almost 50% more profits.  If we could see the company get back to previous profitability, we could get an homerun.  Let’s dig a little…

In 2012, CALM entered into an agreement to create Eggsland’s Best company in a joint venture with Land O’Lakes inc. to create a bigger company on specialty shell egg business marketing and sale.  This created a nonrecurring profit of 38.343 effectively representing 42% of the actual fiscal year net income!  So if we remove this profit from the equation, CALM would have had a reduced net income in 2012 instead of an improved one!  We cannot expect this in a recurring operation so we should see the actual income decreased by 50% next year if operations continue the way they are. 

But CALM purchased Pilgrim’s company and closed the transaction last month.   This producer assets can increase the production by 1.4 million laying hens.  It will have an impact, but not a major one considering CALM already have 26.1 million layers.

Concerning agricultural producers, animal rights lobby are causing a great deal of concerns.  In July 2011 a new law was proposed to increase required living space of pullets from 48 inches to 124 inches!  This law was supported by the United Egg Producers and the Humane Society of the United States.  If this law passes, it may have major cost impact on CALM.

A lot of litigation are also pending judgement or trial.  These could also cause surprises.

Cashflow

The operating cash flows are pretty impressive at almost 90M.  With a market cap at 1B less 200M net cash, you are in front of a business valuated at 8.9 times FCF.

Dividends

The company returns to its shareholders one-third of the quarterly net income.  In the TTM, this resulted in 1.25$ in dividend or almost 3% yield at the current price (42).

Investment analysis

Feed costs are increasing and margins are eroding.  From 11.1 in 2011 to 8.8 in 2012, we can only expect the margin to stabilize next year.  I could calculate earnings at the same level as last year.  While I think the P/FCF is adequate, there is not enough margin of safety for an investment at these prices.  I would prefer investing at a P/E close to 12  so in the 30$ range.  I do think it is worth 40$, it is not a great investment at these prices.

Disclosure : None.

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Posted in CALM

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