Monday, June 15, 2009 2 comments ++[ CLICK TO COMMENT ]++

Cal-Maine Foods (CALM) - A low P/E company

I had an argument over Cal-Maine Foods (CALM) on the GuruFocus message board and I thought I would re-post some of my initial feelings on this company. This is a good example of a low P/E company that I don't feel is cheap (yet).

Cal-Maine is an egg supplier with a market cap of around $590 million. I came across it thanks to the Barron's interview that StockDocx99 re-posted here. One of the Barron's participants, Scott Black, recommends CALM and makes the following comment:

Scott Black: My next pick is Cal-Maine Foods . The stock is 24.81, there are 23.8 million shares and the market cap is about $590 million. Cal-Maine is the No.1 egg producer in the U.S., with a 15.8% market share. In the May 2008 fiscal year, it sold about 678 million dozen eggs -- 535 million dozen were produced in-house. They have 22 million hens, whose laying life cycle is about two years. The stock fluctuates with the price of feed -- corn. In the past year it has been as high as 48.80 and as low as 17. Earnings fluctuate, too. The company earned $6.40 a share in fiscal 2008, and we estimate they did $4.15 in fiscal '09.

Barron's: Take us through your model.

Scott Black: I see revenue of $1 billion in the coming year, up about 4%. Gross margins are 27.5%, or $275 million, and SG&A [selling, general and administrative expenses] is $95 million. The net debt-to-equity ratio is only 16% and interest expense is $6 million. Add it up and you get pretax profits of $174 million. Taxed at 35%, that's net income of $114 million, or $4.80 a share. The stock sells for 5.2 times earnings. That's ridiculous. Return on equity is 31%, and they will generate about $120 million in free cash. The company pays out a third of income as dividends. The current dividend is $1.72, the yield, 7%.

About 85% of Cal-Maine's customers are retailers; the biggest is Wal-Mart Stores [WMT]. If Cal-Maine earns $4.80 a share in fiscal 2010 and trades for just eight times earnings, you've got a $38.50 stock, plus the yield.



CALM is an interesting company because it is a non-distressed company—I haven't done enough research and assuming it is not distressed—that is trading at trailing and forward P/Es of around 5.

Scott Black seems to like the company for its high dividend (trailing dividend of 7.5%) but I wonder about the dividend. Such high dividends tend to be unsustainable so one needs to dig into this company to see if this is a temporary peak.

This is an interesting company worth following. It is not glamourous and is small-cap so it may provide some edge for small investors. Cursory look (without reading annual reports) makes me think the company is not cheap. One may want to wait for a lower entry point.

So far, the things I don't like are the following (I'm copying & pasting from a forum post so the wording is somewhat inconsistent.)

Valuation

Look at the 10 year valuation from Morningstar. In particular, look at the P/E ratios in the top table. Assuming the numbers are right and Cal-Maine isn't a completely different company now (haven't done enough research on this), we can see that CALM traded at a P/E of 4.5 in 2001, 4.8 in 2002, and even in 2006 it was trading at a p/e of 5. In fact, it has historically traded near the current vaule of a P/E of 5.

Even if we look at price-to-sales, it has historically traded at around 0.6x to 0.7x, versus the 0.6x present value. Similar story with price-to-cash flow.

The only ratio that makes it seem somewhat cheaper than the past is the price-to-book-value but even this doesn't seem extremely cheap.

So, in terms of the traditional valuation metrics, such as the P/E ratio, CALM, although not expensive, does not seem out of line with the past. Some people buy stocks when they are fairly priced but I don't. I think now is not the time to buy this. Your returns will largley come from the low P/E (i.e. high earnings yield) than anything the company does. I don't see any margin of safety here.


Earnings & Cash Flow

The other problem with this company is that its earnings fluctuate wildly. Perhaps this is why the market has historically placed at p/e multiple of 5 on this company (a non-distressed company trading at a P/E of 5 must mean something--usually). If you look at the long-term net income, you will see how it has posted a loss almost every other year (e.g. loss in 2000, 2002, 2005, 2006). (I'm not sure if there is some data error since the P/E mentioned above should be negative if there is a loss but I'm assuming the numbers are correct and there is a reason for this (maybe the listed p/e doesn't include negative quarters or something???))

The company has always posted positive free cash flow. Just relying on tabulated numbers, without looking into the actual financial statments, can be misleading at times but I'm not going to do that until I get really interested. Anyway, going with the Morningstar numbers, FCF ranges from around $15m to $190m. FCF in the last few years are really high compared to prior years ($100m+ vs <$80m in past). I'm not sure if this due to an acquisition or if it is due to some cyclical peak earning.

If you think the recent FCF is reasonable, the company looks cheap. But if recent earnings are peaks that won't be repeated for many years, then the company looks average. If you go with the pre-2007 earnings, then the company is not cheap.

To sum up, in regards to earnings, I think one needs to read up on the history in the last few years and see if the post-2007 earnings can be sustained. I am not interested enough (yet) so I haven't looked to see why FCF doubled after 2007. If either net income or FCF stays above $100m, this company seems attractive.

My concern in general, not just with this company, is that profit margins were elevated in the last 5 years and they will decline. It's hard to say, without doing further research and thinking about their industry, if Cal-Maine's earnings are elevated. I think financial companies and commodity businesses had unsustainably high earnings in the last few years but not sure about a poultry company.

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2 Response to Cal-Maine Foods (CALM) - A low P/E company

MrParkerBohn
June 15, 2009 at 2:07 PM

This company certainly looks cheap.  Debt looks reasonable, P/E is attractive, P/S is attractive, P/B (I use tangible book) is reasonable but not attractive.  Revenues are increasing over time.
The extreme cyclicality and swings in profit are a definite minus.
 
There is a question mark for me in current liabilities on the balance sheet, with over $60m in liabilities unspecified by Google finance.  The SEC filings would certainly clear this up.
 
But I'm done with this one, because I now see that there are 23.8m shares outstanding, and there are 2.8m shares short (as of the end of May).  This is a huge short ratio.  My policy is to never oppose heavy shorts unless I am very very sure I am right.
 
Its not that I'm afraid of the shorts manipulating the price - I couldn't care less.  Its just that as a value investor, I like to avoid uncertainty, and one thing shorts are good at finding is high-risk stocks to short.  I wonder what the shorts see here?  Perhaps they are just playing the earnings cyclicality.
 
Regardless, I'm going to chalk this one up to 'too uncertain, too risky' and move on.

Sivaram
June 15, 2009 at 3:07 PM

Yeah, I get a similar feeling as you. Namely, initial feeling is that it has low/cheap metrics. The thing that one needs to check is why earnings literally doubled within the last 2 years.
 
Probably worth checking in 6 months and seeing how things stand...
 

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