Diamond Foods: DMND Is On the Road to Recovery

by Will Ashworth | October 1, 2013 9:34 am

Diamond Foods (DMND[1]) announced fourth-quarter earnings[2] after yesterday’s close. And while investors weren’t happy — the stock gapped down 6% this morning — there’s still plenty to like about this stock.

Two years ago, the bottom fell out of DMND after the company was forced to postpone its purchase of Pringles from Procter & Gamble (PG[3]). Ultimately, P&G terminated the deal, and Pringles was sold to Kellogg (K[4]) for $2.7 billion.

Despite its near-death experience in 2011, Diamond Foods has made an impressive recovery in 2013, gaining 72% year-to-date. Let’s take a closer look at the company to see what investors are missing.

The Past

Diamond Foods’ stock dropped 70% in the span of two months between September and November 2011. Its former CEO and CFO lost their jobs over improper accounting regarding payments to walnut growers. By May 2012, the board hired a new CEO and obtained a $225 million cash injection from Oaktree Capital Management (OAK[5]). The Los Angeles-based private equity firm got a sweet deal: Senior unsecured notes paying 12% interest along with warrants to purchase 4.4 million shares at $10 each.

With money in hand, CEO Brian Driscoll — who was hired from Hostess and once ran Kraft’s (KRFT[6]) sales department — went to work regaining the trust of walnut growers and investors alike. As part of its plan, management sought to rebuild its walnut supply and re-positioning the Emerald brand from 250 stock-keeping units down to 90. It also substantially increase the amount it spent on marketing, advertising and promotion for its four main brands and optimized its cost structure to save at least $35 million per year.

Although its overall revenues have dropped by a significant amount, its margins have recovered to pre-crisis levels.

The Present

Diamond’s stock dropped almost 5% in after-hours trading on its weak outlook for the first quarter. The company “expects to face significant sales and contribution headwinds including costs associated with the Emerald re-launch and lower walnut supply.” With markets up more than 20% year-to-date and investors sporting itchy trigger fingers due to the potential shutdown of the federal government, any negative news means red numbers at this point.

But from a broader perspective, how is the company really doing?

Actually, if you read the rest of its outlook, it’s quite good: “Despite expected increases in tree nut costs, fiscal 2014 is expected to be a year of earnings improvement as additional benefits from the execution of the multi-year turnaround strategy are realized.” Furthermore, the Q4 numbers actually show an improving business when compared to the numbers in Q4 2012.

But to be objective, you have to put aside revenues for its nut segment. By themselves they’re admittedly awful — down 23.4% year-over-year to $426.1 million. However, its adjusted EBITDA actually increased 28% in fiscal 2013 to $101.7 million when excluding one-time expenses such as the $96 million for its securities class action settlement. In addition, sales for its snacks segment increased 3% year-over-year to $438 million, gross profits were up 18.7% to $152.1 million, and its gross margin improved 460 basis points to 34.7%.

On the whole, DMND is in much better shape today than when things went south two years ago.

The Future

Last Thursday, BB&T upgraded DMND’s stock from “hold” to “buy” with a $28 price target. In a note to clients it stated: “Investors will be left with an attractive, instituted cost savings program, improving margins, and in our opinion, a potential takeout candidate.”

Why a potential buyout candidate? Diamond’s Pop Secret brand is number two in market share, Kettle brand chips are number three in adult premium snacks, its Emerald Brand nuts are number three in the snack nut category, and Diamond of California is number one in culinary nuts used for baking.

As Diamond emerges from its accounting mess, you can’t help but think Kellogg would be interested in adding to its snack business beyond Pringles and the various cookie and cracker brands it owns. Other potential acquirers that might be interested in its brands include General Mills (GIS[7]) whose snack food brands include Bugles and Nature Valley granola bars and Kraft Foods with Planters and Baker’s Chocolate.

Bottom Line

Regardless of whether Diamond Foods becomes an acquisition target in the next 12-24 months, I see its prospects in both its snack and nut segments continuing to improve. In the Q&A for its Q4 conference call, Driscoll indicated that 2014 revenue growth for its snacks segment will be about 3% with its nut business experiencing a decline much less severe than the 25% in 2013. Put those together and it’s almost certain profits will improve in 2014. Factor in another year of new cost saving policies, and DMND should grow exponentially on top of that.

As far as valuation is concerned, I don’t believe there’s a packaged foods company trading for less. If its stock drops below $20, I’d be buying like crazy. If not, I’d still be buying. DMND hit the bottom and is on the rise. From where I sit the future looks bright indeed.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.

Endnotes:
  1. DMND: http://studio-5.financialcontent.com/investplace/quote?Symbol=DMND
  2. fourth-quarter earnings: http://finance.yahoo.com/news/diamond-foods-reports-fourth-quarter-200100106.html
  3. PG: http://studio-5.financialcontent.com/investplace/quote?Symbol=PG
  4. K: http://studio-5.financialcontent.com/investplace/quote?Symbol=K
  5. OAK: http://studio-5.financialcontent.com/investplace/quote?Symbol=OAK
  6. KRFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=KRFT
  7. GIS: http://studio-5.financialcontent.com/investplace/quote?Symbol=GIS

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