- The scoring points I use to rate stocks.
- Why Cal-Maine dropped from an “A” to a “C”, but still an “A” in my books.
- Thoughts on Cal-Maine today and the future.
Starting 2016, Cal-Maine Foods (CALM) started off as an “A” grade stock.
The previous year was fantastic for business as it passed by the Avian flu unscathed.
The company ended the year with:
- Great fundamentals
- Great management and company performance
- Great growth
But something happened.
The latest quarterly filing pushed CALM from an A rated stock to a C rated stock.
The question I get often is “how does a stock change so much with your scoring method?”.
I’m a firm believer of the quote by John Maynard Keynes.
“When the facts change, I change my mind.”
But at the same time, it’s just as important to understand what the changes are and why.
Quick Summary of How the Score is Calculated
Criteria that make up our Quality, Value, Growth and Action Score are:
- FCF/Sales (shows how much free cash a company is able to convert from sales)
- CROIC (Cash Return on Invested Capital. Measures how much money company can generate per dollar of FCF)
- Piotroski score (Fundamental scoring system developed by Dr Piotroski)
- P/FCF (Answers the question – how much are investors paying for each additional dollar per free cash flow?)
- EV/EBIT (Answers the question – what is the value per each dollar of EBIT?)
- P/B (Price to book value)
- TTM sales percentage change (Trailing Twelve Months sales change as a percentage)
- 5 year sales CAGR (5 year Compounded Annual Growth Rate)
- Gross Profit to Asset Ratio (GPA – a clean measure of economic profitability)
We use the above metrics to grade all our stocks. The number one reason big changes in the Action Score occur is from a change in the Piotroski F score.
The Piotroski F Score is a compilation of 9 checkpoints a stock is graded on. It is used as the initial filter to calculate each of the Q, V and G grading calculations.
I leverage the Piotroski F Score model extensively because it’s simple and it works. If you apply the F score to stocks as an initial filter, you can eliminate junk stocks and work on the gems.
Think of it like sifting for gold.
You pour mud and dirt into a pan, and then as you shake the whole thing, you’re slowly left with the “cleaner” and “better” pieces in the pan. With what’s left, you can easily differentiate the rocks to the minerals and potential gold.
How this applies to CALM
CALM was rated an A for most of the year, but is now a C.
Why the huge difference?
In CALM’s latest report, they are coming off one of their best years ever. While their competitors suffered due to the Avian flu, CALM weathered the bird flu without issues and took advantage of their competitors mishaps.
All of last year, their demand was at a peak, and egg prices were up because of the demand and limited supply.
Now with the hen population coming back up and competitors “laying eggs” like mad, egg prices have dropped.
More supply, than demand.
In other words, CALM operates in a cyclical commodity based business.
At the moment, you see trends like:
- TTM sales % change being negative
- Gross Profit to Assets dropping sharply as the assets aren’t as profitable with falling egg prices
- P/FCF is 18.9 which is outside of the optimal range of < 10
From the National Shell Egg Index Price Report:
- Demand is light to moderate.
- Offerings and supplies are moderate to heavy.
- Market activity is slow to moderate.
- California delivered prices are lightly tested.
- The undertone is steady to mostly lower.
- Demand is light to moderate for the moderate to generally heavy offerings.
- Supplies are moderate.
- Market activity is slow.
Each point shows you that egg prices are not looking good.
But this is just one side of the story and mostly what is being cited and focused on.
In similar reports by the USDA,
As of today, the market is at least three weeks away from the traditional start of the Thanksgiving demand period but current wholesale pricing should attract increased demand in the meanwhile.
When short term action is the focus for commodity companies, investors will lose.
With such big swings in the industry, this also means that the Action Score will show cyclical patterns.
- Up when growth is strong and the company is making money.
- Down when demand is low or there is too much supply.
The latest quarterly reports show how CALM is now operating back towards the bottom of the cycle, and fundamentally, the Piotroski F score has dropped from a 9 to a 6.
Dropping 3 points is a big factor and will allow other stocks to jump ahead. Remember that I place a lot of importance on the Pio F score.
The tradeoff with mechanical calculations
As a disclosure, I hold CALM and this is no way a defense of my position. I welcome opposing views showcasing fundamentals breakdowns in the company.
But the change from an “A” to a “C” reflect that algorithms (OSV and others) are still backward looking and cannot decipher the complex world we live in.
That’s why for my backtesting, I always use a 20 stock portfolio and hold for 1 year. Best results come from eliminating the desire to go in and start meddling with the process.
There’s a lot of emotion that moves the markets and a stock that started out as an A at the beginning of the year, could easily become a C and then move back to an A.
One example is Nordstrom (JWN) (which I also hold). It was another A grade stock, but the price dropped 30+%, and rallied over the next couple of months and is now slightly higher than my buying point.
Nothing much. Short term emotional traders and negative headlines.
Bad news sells.
My mistake with Nordstrom was that I sold half the position because I got swept up in the fear mongering instead of believing what my eyes told me when I visited stores in Seattle, Portland and Washington DC.
As Walter Schloss once wrote in his 16 point checklist,
“Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.“
Same thing with Hawaiian Airlines.
This time, I didn’t fall for the same psychological behavior.
Instead of looking at news and thinking I was going to dig up exclusive information, I went back to Walter Schloss’ 16 point checklist and ignored the noise.
Cal-Maine Foods Today
CALM is in a similar boat when you look at it superficially or for the short term.
For a mechanical position, it doesn’t look good right now for sure. The USDA tells you how it is.
However, when you peel off that top layer that makes CALM look like another typical commodities company, you see some compelling long term advantages.
- Egg prices will stabilize
- Current numbers are improving from the bottom
- People will continue to eat eggs until they die
- Restaurants are using higher quality eggs as consumers get smarter and demand better products
- Growth and sales from specialty eggs is increasing which CALM is heavily investing in
- Short ratio is high because traders use it as a hedge for their positions because there is no futures market. Not because there is something wrong fundamentally with CALM.
- Ramping up acquisitions and creating joint ventures for specialty egg to increase capacity and efficiency
- Fundamentals are excellent for a commodities company
Fundamentals are strong for the industry the company operates in.
Here are value focused numbers for the stats people.
Despite the current down cycle, CALM is not at all time lows. It’s a testament to how strong this egg company is being run.
Management has been able to foresee, communicate and handle the situation with precision.
They are now taking advantage of current economics to expand through acquisitions and expansions.
In the last VIP email I sent related to Singleton and Teledyne, the great management teams and companies take advantage of down cycles to strengthen their business.
Even with current declining numbers and estimating that FCF will fall to the $100M range, a fair value in the low $40’s is my low end estimate.
Keep in mind that this is a point in time analysis.
Look at what the company can do as specialty eggs expands as well as 5 years down the road.
My fair value range starts to look something like this using simple revenue estimate with the EBIT valuation model.
Using an EBIT multiples method where next year’s expected revenue is $1.5B:
- conservative fair value is $33 if CALM stays at 6x EBIT multiple
- normal fair value is $42 for 8x EBIT multiple
- aggressive $52 fair value using 3 year high of 10.36x EBIT multiple
Valuation range is then $33-$52.
If your view is short term, your valuation is most likely between $33-$40.
If you have a longer term outlook, the range will be from $40-$50.
CALM valuation video
Lastly, I shot a short video using the app to make adjustments.
I shot this last week quickly so the numbers do not match the article which I fine tuned further based on the latest filings.
But that’s the point.
Use Old School Value to quickly turn your assumptions to numbers, see whether it’s worth investigating and then refine the valuation.
Watch this video to see how I make quick adjustments and can come up with a good valuation range in a short amount of time.
Disclosure: Long CALM, HA, JWN.