A Small-Cap Value in a Place You’d Never Expect
If there’s one thing investors should always keep in mind, it’s this: there is a potential investment idea in everything. Even in this market.
For example, every item you find in your supermarket, even the supermarket itself, is a potential investment idea. There may also even be potential investment ideas in the multitude of companies that are involved in getting those items into your supermarket in the first place.
The point is, investors should leave no stone unturned. Some of the most profitable investments are often the ones that are most overlooked.
For example, you may be jonesing for an omelet one morning, but did the investor in you ever think about who makes all those eggs that stock the dairy shelf?
Enter Cal-Maine Foods (Nasdaq: CALM). This small-cap company specializes in one thing: eggs. Believe it or not, this quiet little company has stacks and stacks of hens clucking away, pushing out little piles of gold along with every egg they lay. In 2009, those hens produced 778 million dozen (that’s 9.3 billion) eggs, or about 18% of the country’s consumed yellow-eyes, making them the largest player in the space.
Cal-Maine takes those eggs, grades them, packages them, markets and distributes them in 29 states. If you happen to pick up a dozen and the package says, “Egg-Land’s Best,” “Farmhouse,” or “4-Grain,” then you are enjoying a Cal-Maine egg. Everyday shoppers at Wal-Mart (NYSE: WMT) and Sam’s Club account for 36% of sales. The company also jumped aboard the organic bandwagon — 19% of sales came from nutritionally enhanced, cage free and organic eggs.
Consumer demand may wax and wane with the overall economy, but American consumers love their eggs — demand increases about +1% a year, so the egg market isn’t as fickle as others. Competition in this market is highly fragmented, but Cal-Maine’s operations have allowed it to make 16 strategic acquisitions during the past twenty years.
Anytime a company is involved with both animals and food, there are risks. In Cal-Maine’s case, the biggest risks are tied with the commodities market, and that should not be taken lightly. Two-thirds of the company’s expenses are tied to feed costs. Corn and soybean meal are the essential feed ingredients for all those hens, and feed prices can be wildly unpredictable, sensitive as they are to weather, competitive needs for renewable energy projects, and supply-demand concerns. If the company can’t ram through egg price increases to compensate for feed cost increases, then it could run into trouble. And if feed prices remain high for long periods of time, consumers may balk at paying too much for eggs.
In addition, there are always diets that wag fingers at cholesterol. The cholesterol threat has been downplayed in recent years, though, so Cal-Maine can take some comfort in that. Nevertheless, as a food-dependent business, if something problematic happens to the hen population (a killer virus), egg safety is compromised. Or if there is some kind of environmental scare, Cal-Maine could be exposed. The other irritant is in the form of animal rights groups, who may be able to push through legislative or regulatory requirements concerning hens that unexpectedly raise costs.
There is also an interesting situation concerning management at Cal-Maine. Based on the voting share structure of the company, Fred Adams (Chairman and CEO) effectively controls 54% of the company. The President and COO owns another 14%. Between them, they can basically dictate whatever happens with the company. This should be viewed as a benefit and, possibly, a potential risk to investors. The benefit is that, historically, they have made good choices as to how to run the business and it is reflected in the financials and stock price (up more than +700% since going public in 1996). The risk is that if their plans go awry, shareholders are basically powerless to effect any change.
Speaking of financials, earnings have been hit during the recession. Fiscal 2009 earnings came in at $3.34 a share, and are estimated to be $2.72 a share for this year. Next year, they are expected to pop back up to $3.24 per share.
Nobody likes to invest in a company whose earnings are declining, but in this case, the company has $60 million in net cash and is due to receive another $33 million from a litigation settlement with a securities firm. The company is on sound financial footing — it is both profitable and cash-solid.
With the company now trading at a less than 12 times earnings, and expected to see +20% growth next year, it may be a great time to find gold inside this henhouse.