The CALM approach.
Consumer Staples are often viewed as a safe haven in a faltering economy; however, we believe debt levels of businesses in the sector could separate the winners form losers against the current backdrop. Cal-Maine Foods, Inc. (CALM) is an example of our thinking.
Cal-Maine is the largest egg producer in the U.S., offering its products under the Egg-Land’s Best, Land-O-Lakes and Farmhouse brands as well as through its private label division. The egg industry is highly fragmented, and excess production during recent years has resulted in significant pricing pressure.
Lower prices could disproportionately affect smaller players as well as those with marginal balance sheets. This dynamic should favor Cal-Maine with its greater scale and strong balance sheet. The company is well-positioned to opportunistically acquire smaller players, which should translate into greater efficiency. Additionally, we believe egg prices will firm as production capacity shrinks due to industry consolidation.
As supply/demand dynamics improve, we believe Cal-Maine could reach valuations of 3x book value, up from its current 1.9x level.
Health Check. The global spread of COVID-19 has put a spotlight on the Health Care sector and many pharmaceutical companies in particular, as scientists race for a vaccine against the virus. We’ve long been scouring the space for compelling opportunities. That work led to our position in Johnson & Johnson (JNJ), a stalwart in the Health Care sector.
Shares of JNJ have been shadowed by concerns related to its liability tied to opioid production. Based on historical valuations, at the time we initiated our position, the market was assigning a $32 billion liability tied to opioid settlements. That liability figure was excessive in our view but provided an attractive opportunity to buy a well-run, industry leading business.
In the time since we initiated a position, valuations have improved, suggesting that others have begun to see the firm’s opioid liability as lower than originally forecast. We believe over the coming quarters, JNJ will return to trading at valuations equal to or slightly above those for the S&P 500.