Update: Cal-Maine Foods (CALM)

February 26, 2008

Update on Cal-Maine Foods (NASDAQ: CALM)

On December 28, 2007 I recommended a BUY on Cal-Maine Foods (CALM) at $27.82 due to the strong earnings quarter, low-valuation on a P/E basis, continued consolidation in the egg producing industry, strong shell egg pricing in the U.S., and a large short position in the stock.

On Monday, the stock closed at $34.50 - up 24% from my first recommendation. You can see my first post here:


This is a large run-up that puts Cal-Maine Foods in a much riskier position for new purchases, but the fundamental reasons for buying the stock all remain intact. So this is now more of a speculative play, rather than a pure valuation play, but I remain bullish in the near term for CALM for several reasons.

First and foremost, the success of CALM will be driven almost entirely by the price of eggs. Watching the run-up to the big Easter season, the price of eggs has remained extremely strong, and I think the coming quarter earnings will likewise be very strong, perhaps $1.90 per share or more. Looking at the demand and the price of eggs from the USDA data shows high demand, but more importantly the historically high price of eggs has not slid at all. (Look at the blue line and right-side axis of the chart on the bottom of the USDA report from the link below.)

USDA Data

The price of eggs has not starting to dip yet at all before the Easter season, a strong indicator of another month of high egg prices. This is good for Cal-Maine Foods margins.

Interestingly, during this stretch we have seen the Short position in the stock surge. In late December there was a little more than 50% of the float shorted. In January we saw that increase to 66%. This past weekend the short position reached an eye-popping 74% of the float. Usually this high a short position raises red flags for me, but there are a couple of factors supporting my bullish stance. First, there is a very large position held by the Chairman, making the float smaller - and more stable - than in other larger traded stocks. Second, Cal-Maine Foods is primarily hitched to the price of eggs for its earnings. This is a commodity price we can watch through the USDA. As long as the price of eggs remains high, I believe CALM will also stay strong.

The big run-up in the stock does provide some pause for new entry points, however. The flip-side of course is that there is a growing short position that is underwater right now - many of these short-sellers are now down 10-15% or slightly more. If the stock rallies after the earnings announcement even $2-$3 dollars, these short-sellers are going to be down 25% and feeling intense pressure to cover their shorts. The classic short squeeze. Many will not want to hold out for falling egg prices later in the year because there is also a new dividend policy going into effect in March, which is going to hurt them even more.

The new dividend policy will have Cal-Maine Foods paying out one-third of its quarterly earnings in a dividend payment. Short sellers will have to cover the dividend payment as well.

The potential for a good quarter, and a short squeeze, makes CALM a good short-term play for a quick run-up of another 10-20%. But this also makes the stock a little more volatile, and one that needs to be closely watched.

If we see another $2 move up in price in the stock, watch for a run on a short squeeze that might run the stock up further.

If there is a pull-back on the stock in the next few days, I will likely add to my position ahead of this quarter's earnings announcement. Be careful where you enter, but more importantly watch where the price moves on quick notice - don't turn your back on this one for days at a time.