Cal-Maine gets a Barron's boost, but is it a value trap?

Eggs might be a consumer staple, but that does not mean that producing them is such a straightforward process. On the contrary, egg prices are marked by high seasonality and cyclicality, and the industry is very fragmented. The USDA monitors the prices of eggs, and in a two-month period earlier this year, the average price in cents per dozen for large eggs varied between more than 121 and less than 66. Cycles and limited pricing power are a fact of life in commodity businesses, which makes it extremely difficult -- if not impossible -- to earn above-average returns on capital over time.

The model that Black outlines takes little of this into account, instead projecting that the good times in the egg business will continue on indefinitely. His top-line revenue estimate of $1 billion, or a 4% gain, does not match with egg price trends; according to the USDA (see link above), prices in 2009 have been below those of 2008, often by a substantial amount. The estimate that gross margins for the company will average 27.5% this year has only been surpassed twice in the past decade (last year being one of those times). Put together, the two primary assumptions do not seem to suggest that Cal-Maine stock is any great value, unless business conditions are extraordinarily well this year, and continue to be perceived by the market to be similar in the future. I see that combination as highly unlikely to be true.

What may be most telling is the differential between what the public market values Cal-Maine at based on its primary earnings driver and what the private market transaction values similar assets at. In this case, Cal-Maine earns money from its flock of hens; Black says the company has 22 million layers. With a market capitalization of approximately $580 million, that values Cal-Maine at $26/layer, excluding all other assets.

For purposes of comparison, the company has made two purchases of smaller operators in the last year. The first transaction for Zephyr Egg and their two million layers works out to just under $15 each, excluding other assets; the second for Tampa Farms and their four million layers shortly thereafter was for just over $15 each, again excluding other assets. This is not to say other assets have no value, but at the most basic level the market values Cal-Maine's layers at 70% more than those of a private seller with extensive industry knowledge.

Applying the private transaction multiples to Cal-Maine's layers suggests a more likely value is around $15/share. Even giving some incremental value for the benefits that come with scale (there is no argument Cal-Maine is the largest player in the industry), it's difficult to justify the current price, much less the price target given in Barron's.

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(As a note of disclosure, the club -- which I am now the vice-president of -- ultimately voted to buy the shares and still holds them today; I voted against doing so and have no personal position.)