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.

Jan. 14 - Buy Recommendation: Annaly Capital Management (NLY)

BUY – Annaly Capital Management, Inc (NYSE: NLY)

Annaly Capital Management, Inc. (NLY) is one of the most pure stock plays on further interest rate cuts from the Federal Reserve. It’s also a favorite position for institutions and has had a nice run up in the last six months, but it has room to still appreciate and sports a nice dividend yield to boot.

Annaly operates as a real estate investment trust (REIT) and invests primarily in mortgages through collateralized mortgage obligations (CMOs) agency callable debentures, and similar portfolios of mortgage pool loans. NLY net income is a result of the interest rate spread between its investments and its capital borrowing costs. Thus, whenever the Federal Reserve cuts interest rates it is an automatic increase in Annaly’s margins at deployed capital.

In the current environment with the sub-prime lending crisis, it is also important to recognize that the bulk of Annaly’s investments are purchased through agencies such as Fannie Mae and Freddie Mac. And regardless of the interest concerns and defaults of individual mortgages, the federal government would not be willing for these agencies to default on their payments. So Annaly does not take the investment risk of their portfolios.

In effect, Annaly’s profitability is a direct play on the direction of interest rates.

Earnings increased 150% in 2007, with an expected additional increase of 90% in 2008. This should support the stock price for the foreseeable short term future. In addition, NLY just raised their dividend rate again, and is now yielding about 7.4%. With even a modest amount of capital appreciation from the $18.50 area to $19.44 in 12 months would provide a total return of 12.5 % assuming no further increases in the dividend.

I am however, neutral on its recent price increase in the stock. Although I have a small position already, I have recently placed limit orders to buy at $18-$18.20 per share. I would like to see the stock retreat this 3-4% to improve the appreciation potential.

January 7 - Cover Short SBUX

Okay, sometimes it's better to be lucky. Earlier in the trading session I decided to cover my short position in Starbucks (SBUX). After the close of trading today, Starbucks announced that CEO Jim McDonald was being ousted and replaced by founder and chairman Howard Schultz.

Because of the view of firing a floundering CEO will be seen as positive news for the stock, and I expect it to open to big gains on Tuesday, anyone that took my recommendation to Short SBUX would be wise to cover the short and protect the remaining gain.

Looking back at some other recent recommendations, Jacobs Engineering Group (JEC) has pulled back to its 50-day moving average, bouncing off that support level in today's trade. The fundamental reasons for buying this stock remain intact, and I like it at this price point of $91.28. However, the stock sold off in high volume trade a big 5.5% today, and I will need to see some support and strength in the stock before adding to this position. Continued weakness and breaking the 50-day support would likely take any technical traders to sell, causing more weakness. Wait with this position to see some rebound with strength.

Mindray Medical Int'l (MR) is less sensitive since this stock is a play on their upcoming 12 months of product lines coming out. I would feel comfortable adding to this stock at the current $40.05 price.

Intercontinental Exchange (ICE) is harder to figure. Great story, fundamentally strong, but because it sells at a P/E of 50 it does require confidence of its shareholders. It is off 15% from its highs - in a quick one week sell-off. I still like the company, but the stock itself may now be under pressure. Volume today picked up in another down day. I am currently holding my position but watching it very closely.

Cal-Maine Foods (CALM) has surprised me in its weakness, down now to $23.67 and a P/E of 6, despite record earnings, no negative news, and forecast of strong price of eggs. I am looking at adding to this position. Effective March 1, a new variable dividend will pay out based on its earnings for the quarter, which I expect to be healthy quarters the next two accounting periods. High short interest means there should be a support for buy-backs and possible short squeeze if the price starts to run. If the next quarter numbers are also strong, I hope to see the price run up significantly.