This Hidden Gem Is Putting All Its Eggs in One Basket
Lately, I've been working on rejiggering my CAPS portfolio and promoting some of my current CAPScalls to top pick status. Next up is Cal-Maine Foods (NAS: CALM) , another hidden gem that has been laying golden eggs for investors for some time now.
Not all it's cracked up to be?
Cal-Maine lacks one of the main features I look for in a business -- diversification. I like Brasil Foods (NYS: BRFS) , for example, because it focuses on the meat market but doesn't favor any meat in particular, and gets its sales in many different regions. This allows the company to benefit from the stability of developed markets, where meat consumption stays pretty steady, as well as the rapid growth of emerging markets, where a rising middle class is improving its diet by consuming more protein. By not favoring beef, chicken, or pork, Brasil Foods is able to avoid betting on what will be a favorite in an often culturally sensitive market.
Cal-Maine has neither of these features. It is a pure play on egg consumption in the United States, which isn't exactly the hottest growth industry right now. In fact, per capita egg consumption in the United States has stayed pretty much the same for the last few decades.
Investing in the fertile fields of growth
So why do I like Cal-Maine if it's focused solely on a stagnant industry? Because it still has a few tricks up its sleeve. For starters, the egg industry is highly fragmented. Cal-Maine is the largest producer but only controls about 18% of the entire market, so there is still ample opportunity for Cal-Maine to grow through consolidation.
Another part of Cal-Maine's strategy is to focus on where the growth is. According to the Organic Trade Association's 2011 industry survey, organic food sales have grown at about 13.4% annually for the past nine years. Cal-Maine's specialty egg sales include other things besides organic eggs -- such as cage-free eggs -- but they still benefit from the same tailwind.
The trend can be most easily spotted at Dean Foods (NYS: DF) , whose mostly organic WhiteWave-Alpro segment has grown from 11% of sales in 2005 to 16% in 2010. Dean's more traditional dairy group segment has grown sales only about 14% during those five years, while WhiteWave grew at 11% annually.
Cal-Maine is tapping into that same source of growth. The company doesn't break its sales into segments, but in 2006, specialty eggs represented only 14% of sales, and in 2011 they had grown to 24%. In addition to the growth prospects, specialty eggs tend to have a higher and less cyclical price than conventional eggs, which should help to stabilize Cal-Maine's rather erratic gross margin as the segment becomes a bigger part of sales.
The Foolish bottom line
It should be noted that the food industry is highly cyclical, and its profitability depends on the cyclical nature of input costs. Fellow poultry producers have been having a terrible time recently contending with a downturn in poultry selling prices and a surge in the cost of corn and soy for feed.
Pilgrim's Pride (NYS: PPC) , for example, has seen its operating margin move steadily down since emerging from bankruptcy in 2009, and has been issuing debt to bolster its declining balance sheet. With negative gross margins for the last three quarters, Pilgrim's is relying on this new debt to service old debt, a sure recipe for a fresh bankruptcy.
Even the venerable Tyson Foods (NYS: TSN) saw its operating margin for the last quarter get crushed 3 percentage points, as its profitable beef and pork operations weren't enough to make up for the chicken segment falling into a steep loss. Tyson should be able to recover more quickly than Pilgrim's, but at an enterprise-value-to-free-cash-flow ratio of 21, it's hardly the cheapest company in the business.
Cal-Maine, however, is. It boasts one of the lowest EV-free-cash-flow ratios in the industry, as well as one of the highest dividend yields. The market is pricing this stock as if it's just another chicken running around with its head cut off. I don't think that's true. I think Cal-Maine is a cheap stock with a lot of growth ahead of it, and so I'm flagging it as one of my CAPScall top picks.
Add these companies to My Watchlist to stay updated as the chicks start to hatch.
At the time this article was published
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