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CALM - A Rebuttal Against Herb Greenberg at CBS MarketWatch

(August 4, 2004)

Please read our disclaimer before reading the following information.  Be sure to utilize a hard stop in each trade that you make!

CALM: In today's "RealityCheck" column on CBS MarketWatch, Herb Greenberg covered Cal-Maine, the latest stock that we put on our watch list (again) on Sunday evening.  In our Sunday article, I covered mainly the technicals of the stock - emphasizing the huge short interest in the stock (over 130% of the float) and the potential bullishness of this lopsided situation - especially given the fact that I was bullish on the stock market in general. 

Herb Greenberg, in turn, wrote a damning article on the company.  His argument against investing or establishing a long position in the company?  Answer: Surprise, surprise -- a recent weakness in shell egg prices.  Of course, it only took him a whole page of text to illustrate this point.  I do not know what his agenda is, but I personally believe his article is very misleading - and moreover, I believe the ultimate reason for him in writing a whole page of text to illustrate his point is precisely that - to mislead.

I will first provide some numbers straight from the recently published USDA reports on egg prices and inventory.  According to the most recent inventory report released by the USDA, weekly egg inventory for all grades of eggs in all five regions of the United States is only up 7% as of August 2nd, not the 10% that he mentioned in the report.  Secondly and more importantly, the weekly national retail egg purchases as of July 30th were 11% above the prior week and 5% above estimates.  During this week, national purchases are projected to decline by 15% principally due to seasonal factors.  The fact that purchases were underestimated during the prior week does not bode well for Greenberg's argument that:

"Now, according to the USDA, demand is "light to moderate," while inventories, or supply, were up 10 percent from a week ago."

Now, I do not like to play with words, but I can recognize an author trying to do this exact thing from afar.  What Greenberg was trying to do was somehow give the impression that the egg market consists of a light demand situation linked with a high supply situation - thus crashing egg prices and falling revenues,  when in actuality, that statement is grossly misleading.

In no portion of the article does Greenberg mention the seasonality of egg prices.  A quote from the company's latest 10-Q: "Retail sales of shell eggs are generally greatest during the fall and winter months and lowest during the summer months. Prices for shell eggs fluctuate in response to seasonal factors and a natural increase in egg production during the spring and early summer."  Readers that are genuinely interested in the seasonality of egg prices may want to check out the historical financial reports of the company, but following is the relevant chart published by the USDA:

Combined Regional Average Price Cartoned Large White Eggs (cents/carton)

First and foremost, Greenberg ignores the fact that we are now in the season historically known for high supply and low egg prices.  In his article, Greenberg gives the impression that egg prices have been plunging because of a huge supply increase (and less demand) when the main (and probably only) reason for recent declining egg prices is seasonality.  Please note the low egg prices that we are currently experiencing are comparable to the 2002 and 2003 years.  Moreover, we are now entering the Fall and Winter period - when demand and thus prices of eggs are projected to rise.

The author also does not know how Greenberg came up with Cal-Maine's cost of 65 cents for a dozen eggs but again, he misleads his readers when he mentions that the 69 cents per dozen charged by Cal-Maine "puts it barely ahead of Cal-Maine's cost of 65 cents for a dozen."  Dear readers, please note that Cal-Maine produced 154.7 million dozen eggs for the fiscal quarter ending February 28, 2004.  A 4-cent profit for each dozen would give the company a 50-cent per share net income during the quarter (which is still a very respectable number).  This is assuming that prices stay at 69 cents a dozen.  If/when prices start moving back up soon, then net income would definitely surpass this going into the Fall and Winter period.  Moreover, it is interesting to note that for the 39 weeks ending March 1, 2003, the average selling price for eggs were 63.1 cents.  Given Greenberg's assumption, Cal-Maine would have lost money.  Instead, Cal-Maine made 67 cents a share in net income during that 39-week period.

Given Cal-Maine stronger financial position today, my guess is that a significant part of Cal-Maine's expenses will decrease given the decrease in interest cost associated with the pay down of their long-term debt.

Cal-Maine has historically done better when feed prices have increased.  Greenberg, in his next paragraph, then states the following: "Meanwhile, don't expect Cal-Maine to make up for plunging prices if the cost of chicken feed falls, as is expected.  According to the company's 10-K, Cal-Maine warns that low feed costs can encourage industry overproduction, possibly resulting in lower egg prices."  First of all, it is important to note here that chicken feed is mostly made of soybeans and corn.  Following is a weekly chart of near-month soybean prices dating back to late 2002.  Maybe Greenberg is a trend-follower when it comes to speculation but soybean prices are already down more than 40% from their highs just three months ago.  Corn also has a similar looking chart.  Why is Greenberg expecting a further decline here?  Furthermore, it is particularly interesting to note that feed prices have declined in a huge way in the last few months and yet, total egg production in June in the United States is only up 2% from June of last year.

A weekly chart of near-month soybean prices dating back to late 2002

In the final sentence of the same paragraph is another misleading statement - that because of periodically low feed costs "Cal-Maine has lost money in nearly half its quarters as a public company."  Now, this sounds pretty bad, but I went back to the company's various annual reports and I can report that besides the 1995, 2000, and 2002 fiscal years, the company has made money in all the other post-1995 fiscal years.  The main reason for the loss in fiscal 2002 was the huge decline in average selling prices - the average selling price during fiscal 2002 was 54.9 cents (note: given the author's belief that we are currently in a commodity bull market, I do not think such a low-ASP scenario will happen again in the foreseeable future).  The fact that interest expense was also near a historically high amount of $8.5 million didn't help either.  Because of its stronger financial position today and management's ongoing debt reduction strategy, I do not expect interest expense to rise above $7.5 million going forward.  This $1 million "savings" in interest expense should translate to approximately 8 cents in additional earnings on an annual basis.

Finally, Greenberg even trashes the recent announcement by Cal-Maine to repurchase up to 2 million of its own shares - by writing this at the end of his article: "P.S. When first quarter results are announced in September, don't forget to check the share count . Announcing a buyback is different than actually doing it."  Based on the tone and style of his writing, one would have think that he was talking about the management of Enron or Tyco.  From a purely supply and demand standpoint, a share buyback is bullish - no question.  Enough already!

Henry K. To, CFA

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