One of my best friends has been asking me this question for around 15 days. I tried to give a quick (and elusive) response, but it didn’t work.. so I decided to give him a more reasoned answer, trying to justify why I think what I think of Diamond Foods (NASDAQ:DMND).
Diamond Foods business refers to snack products and culinary. It has three product lines: Snack, Culinary and Retail In-shell and Non-Retail. The company has a wide range of distribution channels and product facilities in the US, Canada and England.
But let’s have a look at the series of recent events that led the investing community to flee away from DMND.
The Pringles deal
On April 5, 2011, the CEO Michael J. Mendes announced the merge of P&G’s Pringles Business into Diamond Foods, giving its shareholders hopes for a bright future (the stock price reached over 90$ in September 2011).
Pringles was valued at $2.35 billion, and would have given Diamond access to an enormous market, with global wide distribution channels. DMND would have reached the 2nd place in the snack market ranking list.
The deal would have been closed by issuing a (fixed number) of Diamond Foods common shares for P&G shareholders.
This means: higher the DMND price on the day of the deal, higher the rewards for PG shareholders.
Unfortunately, it also works in reverse…
The walnut payments mess
As Walnut-based snacks account for more than 30% of DMND sales, walnut prices have an huge impact on the company financial health.
Diamond used to stipulate multi-year contracts with walnut growers in order to protect itself from price volatility. This habit was not a big issue in the past years, because, excluding crop payments price adjustments (the walnut prices takes into account the riskiness of the land, the season, unexpected weather events, etc.), the walnut business has been quite stable in the past.
The recent price hike has been disadvantageous for DMND suppliers as their peers were able to sell the same qualities of walnuts for a bigger price.
At the end, Diamond was forced to make some additional payments to compensate growers for their inadequate remuneration.
On the other hand, DMND was in the midst of its Pringles merge, so they didn’t want to have the stock price too affected from this news.
But at the end of September, the WSJ and other financial newspapers reported that Diamond had issued a “momentum” payment to growers in order to compensate them for the new market environment (read: increased walnut prices).
The problem was: DMND fiscal year ends on July 31, so, in the “record” 2011 results, reported on September 15, 2011, there were obviously no traces of additional payments..
On December 12, 2011, (that was also the timeline for the filing of the 10-Q Form related to its fiscal first quarter) Diamond Foods updated its shareholders saying that the 1st quarter results would not have been available until the end of the internal investigation on the additional crop payments carried out by its Audit Committee.
On February 8, 2012, the company announced the Audit Committee Investigation Findings: the committee stated that the crop payments (especially the $60 million made to growers in September 2011) “were not accounted for in the correct periods” and that 2010 and 2011 financial statements will need to be restated.
This announcement caused the stock to further collapse by almost 40% in a few days.
Finally, on February 15, 2012, as the last step of this long escalation, Diamond Foods announced the termination of the Pringles transaction with PG. Of course, at these prices, it was impossible to implement the deal with a stock swap, and, additionally, on DMND balance sheet as of July 31 there’s practically no cash, so at this point it would have been impossible to pay $2.35 billions to PG, either in cash or stock.
Out of pure curiosity, on the same day, Kellogg announced its agreement with PG to acquire Pringles business: what a timing!
The Pringles acquisition was (now is clear) for Diamonds a good way to diversify the business reducing its dependence from a little set of raw materials.
It is evident that they didn’t manage to do it in time.
As of today, DMND normalized P/E is slightly below 10, the debt/equity ratio is bigger than 1, the ROI is in the mid-single digits.
I agree with Frank Voisin (here you can find his article) on the fact that the company is not so cheap and will continue to be so also if its doubtful accounting techniques could be justified in any way.
In the meanwhile, DMND has taken some steps like changing top management and rise snack prices in order to straighten the sinking ship.
Some questions to be addressed:
- Will the new management fix all the issues (if any)?
- Will walnut prices come back to more normal levels or is it a structurally growing trend?
- Will competition in the snack business increase?
I’m not currently able to give a price range for DMND because, referring to the next years, its business dynamics are quite unpredictable (especially for me: the snack business is quite far from my circle of competence).
I think my friend was attracted by the recent DMND price collapse, and by the fact that food companies usually trade at high multiples of earnings and cash flows, because of their predictability and of the loyalty of its customers, so giving a look at these companies from time to time could unveil some profit opportunities (see TSCDY recent story).
Anyway, here I don’t see belts or suspenders for DMND stock price in case of new bad announcements, so that’s an easy choice: pass.