Why The Many, Many Shorts Are Wrong About Cal-Maine

July 16, 2015 |

Recent articles on Cal-Maine (CALM) have focused on how the company, whose flock is mostly in the South, will prosper from avian flu wreaking havoc on Midwestern egg suppliers. This is how CALM, the country’s largest egg supplier, can have a current P/E of 18 and a 2016 projected P/E of 5: their production is unscathed while national egg prices spike. But beneath that short term trend is a company worthy of long-term consideration. Cal-Maine has strong management and growth prospects, a solid dividend policy, and a 30% short interest, which leaves the potential for a short squeeze.

The Growth Story

Cal-Maine is the largest egg producer in the U.S., accounting for 23% of shell egg sales. Over the past several decades, the company has grown through capital expenditure, acquisitions and joint ventures, and management will likely continue to employ all three strategies going forward. The company currently has plans in place to increase non-specialty egg capacity by 1.3 million hens and specialty (chicken industry lingo for organic and cage-free) eggs by 1.1 million hens. For context, the company currently has 34.2 million laying hens – which, if you think about it, is an absurd number of chickens. In the past year, overall sales are up 9.7%, and specialty egg sales are up 22%. Specialty egg sales, which account for about a quarter of CALM’s revenue, are higher margin and less cyclical than regular eggs.

Acquisition is a strong strategy for Cal-Maine because it allows the company to grow and expand market share without increasing overall egg supply. Cal-Maine does give investors some exposure to commodity price volatility, both in terms of feed costs and the egg market. Egg sales are weakest in the spring and summer and stronger in fall and winter. While both of those markets can go through medium-term cycles, the long-term trend for egg prices is positive. Cal-Maine has also built a very healthy balance sheet, which provides some shelter against volatility.

The Balance Sheet

Acquisitions are made easy by the pristine nature of Cal-Maine’s balance sheet, which we can see over a 10-year period using Stock Rover below. The company has very safe current and quick ratios, meaning they can easily cover their short term obligations. They also are burdened by very little debt, which they’ve been reducing over the years while simultaneously building equity. The company has few intangibles on its balance sheet, a result of not overpaying for acquisitions, as well as the limited monetary value of brand names in the egg supply industry.
CALM Balance Sheet

While some investors prefer more aggressively leveraged businesses, I like what Cal-Maine has done here. The balance sheet health both provides insurance against cyclicality and enables growth, and I think it’s a sign of strength that CALM has been able to reward shareholders and grow sales at a strong pace while also strengthening the balance sheet. I also have a personal preference for more conservative leveraging.

The Dividend

Cal-Maine’s dividend policy provides an additional layer of exposure to egg market cyclicality, but has also provided solid returns to investors. The company automatically pays out a third of their earnings in every positive quarter as dividends. This has produced a considerable degree of dividend volatility, as you can see below, but has also produced a yield consistently in the 2-3% range. The policy works well for Cal-Maine, as it allows them to maintain a strong cash position in all kinds of environments. It certainly provides intriguing dividend growth potential, though investors actively drawing on dividends for income might want to balance their portfolio with more consistently-paying stocks.
CALM Dividend

Short Interest

Another element to Cal-Maine is the short interest in the shares, which has been growing from 32.9% of float in mid-June to 36% at month’s end. In some cases, this could be a warning sign that something was wrong with the stock, but shorts have been wrong about CALM before. The short position in CALM has grown pretty steadily over the past year, with two notable periods of growth in late October-early November 2014, and April 2015. Investors who shorted in October and closed their position in February did quite well. Investors who shorted in April have – to use a technical term – gotten hosed. While the company’s valuation is relatively high historically, I think Cal-Maine’s fundamental strength makes the shorts unwarranted.
CALM Price One Year

In fact, CALM has consistently carried a high short interest. Here’s an article describing the a 40% short of float in 2004, and here’s a very wrong short recommendation from 2013. The stock has historically carried a lot of short interest, as you can see here and here. I’m not sure I can explain the short interest in CALM, maybe it has something to do with fear that commodity prices will hurt the company, or volatile earnings and share price, or that the company is overvalued. All I can say for sure is that if you look at a 10-year history of the stock below, some of those shorts have probably made some money. But boy, the majority of those shorts have gotten killed.
CALM Price Ten Year

Of course, if the shorts stay committed, then no short squeeze occurs. Since the stock has carried so much short interest before, I think the shorts might stay committed, especially since closing their positions is going to hurt. But the high number of shorts is still having a depressive effect on share price. The way I think about it, 100% of demand for Cal-Maine stock is currently being serviced by 130% of supply, plus or minus the net effect of options. The short interest currently requires about 13 days to close, so it definitely has the potential to buoy the stock at an indefinite future time.

Conclusion

Cal-Maine is disciplined with their capital allocation, with a healthy mix of shareholder reward and growth. The balance sheet is exceptionally strong, and I trust management to adapt to commodity price volatility. The large short interest adds another dimension. However, stock is coming down from an unreasonable high, and so investors may want to wait and see for a couple weeks before entering a position. The egg supplier’s prospects are, forgive me, sunny-side up.





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