There was big news on the snack food aisle today: Diamond Foods (DMND), the company behind Emerald brand nuts, purchased the Pringles brand from Proctor & Gamble (PG) in a deal valued at $2.35 billion ($1.5 billion in stock, plus assumed debt). This marks the continuation of a big push for growth at Diamond Foods, which acquired Pop Secret in 2008 and Kettle in 2010, and will triple revenues as a result of the Pringles transaction. The stock popped more than 10% on the news, indicating that Wall Street is very pleased with the move at Diamond Foods. However, I have one key concern as a potential investor: When do we need to start worrying about the cost of these transactions, and will the company be able to continue moving forward as they fight a sizable (and growing) debt account?
At the end of 2007, Diamond Foods looked very different than today; the company had total debt of roughly $20 million and was paying a paltry $1 million to finance it, with a more than adequate interest coverage ratio of nearly 24x (2007 EBIT of $24 million). On top of that, they had $30 million on the books, suggesting that debt was hardly an issue. However, this changed with the 2008 acquisition of Pop Secret from General Mills (GIS) for $190 million in cash, followed by the 2010 acquisition of the Kettle brand from Lion Capital LLP for $615 million (also in cash). As of their most recent filing, the company has more than $550 million in debt between their long-term obligations and revolving line of credit (compared to $2.2 million in cash), and had paid $5.99 million and $12.1 million in interest expense in the three and six months ending January 31, 2011, respectively. This compares to EBIT of $35.9 million and $63.47 million for the same periods, which works out to an interest coverage ratio of 6x and 5.24x, respectively. These figures aren’t much of a disturbance, but paint a different picture as of this morning. When we add in the $850 million of assumed debt that Diamond Foods has received in the Pringles acquisition, we are looking at a debt holding of more than $1.4 billion, a figure which currently outpaces the company’s market cap.
However, it is unfair to look at the liabilities without looking at the subsequent results, which could very well justify the capital structure. Since year end July 31, 2006, revenues and diluted EPS has increased at a compounded annual growth (CAGR) of 9.26% and 30.42%, respectively. The snack business, which houses the core brands (Emerald, Kettle, Pop Secret), has seen impressive top line growth of more than 90% over the past two years due to acquisitions; this trend will now be extended in a big way with Pringles, and is in line with the company’s first strategic goal from the 10-K: to continue to grow our revenues by increasing our market share in the snack category. With Pringles, they picked up roughly 10% of the potato chip market (based on P&G estimates), which doesn't include their share from Kettle. As they continue to push growth in retail sales (which increased 22.6% YOY) and become a bigger part of their customers (meaning retailer customers) business, they will have a greater opportunity to achieve this strategic goal.
With the addition of Pringles to an already strong product line, Diamond Foods will continue on what has already proven to be an impressive growth curve, and will triple revenues to approximately $1.8 billion in 2012. The debt and interest expense look manageable for the time being, but will certainly hamper the bottom line results over the next couple of years. Based on management’s forecast, Diamond anticipates FY2012 EPS to come in between $3.00-$3.10, excluding costs associated with the Pringles deal. At more than 20x forward earnings and with a sizable debt position, investors are paying a pretty penny in expectation of strong growth. While I see the merit for this position based on the brands in the portfolio and what management has achieved since the IPO in 2005, I’m personally hesitant; this is the kind of company that I would love to see cut their dividend, and instead focus on funding growth and dialing down interest expenses. Based on the debt load and the recent jump in price, I’m going to hold off on Diamond Foods for the time being.
At the end of 2007, Diamond Foods looked very different than today; the company had total debt of roughly $20 million and was paying a paltry $1 million to finance it, with a more than adequate interest coverage ratio of nearly 24x (2007 EBIT of $24 million). On top of that, they had $30 million on the books, suggesting that debt was hardly an issue. However, this changed with the 2008 acquisition of Pop Secret from General Mills (GIS) for $190 million in cash, followed by the 2010 acquisition of the Kettle brand from Lion Capital LLP for $615 million (also in cash). As of their most recent filing, the company has more than $550 million in debt between their long-term obligations and revolving line of credit (compared to $2.2 million in cash), and had paid $5.99 million and $12.1 million in interest expense in the three and six months ending January 31, 2011, respectively. This compares to EBIT of $35.9 million and $63.47 million for the same periods, which works out to an interest coverage ratio of 6x and 5.24x, respectively. These figures aren’t much of a disturbance, but paint a different picture as of this morning. When we add in the $850 million of assumed debt that Diamond Foods has received in the Pringles acquisition, we are looking at a debt holding of more than $1.4 billion, a figure which currently outpaces the company’s market cap.
However, it is unfair to look at the liabilities without looking at the subsequent results, which could very well justify the capital structure. Since year end July 31, 2006, revenues and diluted EPS has increased at a compounded annual growth (CAGR) of 9.26% and 30.42%, respectively. The snack business, which houses the core brands (Emerald, Kettle, Pop Secret), has seen impressive top line growth of more than 90% over the past two years due to acquisitions; this trend will now be extended in a big way with Pringles, and is in line with the company’s first strategic goal from the 10-K: to continue to grow our revenues by increasing our market share in the snack category. With Pringles, they picked up roughly 10% of the potato chip market (based on P&G estimates), which doesn't include their share from Kettle. As they continue to push growth in retail sales (which increased 22.6% YOY) and become a bigger part of their customers (meaning retailer customers) business, they will have a greater opportunity to achieve this strategic goal.
With the addition of Pringles to an already strong product line, Diamond Foods will continue on what has already proven to be an impressive growth curve, and will triple revenues to approximately $1.8 billion in 2012. The debt and interest expense look manageable for the time being, but will certainly hamper the bottom line results over the next couple of years. Based on management’s forecast, Diamond anticipates FY2012 EPS to come in between $3.00-$3.10, excluding costs associated with the Pringles deal. At more than 20x forward earnings and with a sizable debt position, investors are paying a pretty penny in expectation of strong growth. While I see the merit for this position based on the brands in the portfolio and what management has achieved since the IPO in 2005, I’m personally hesitant; this is the kind of company that I would love to see cut their dividend, and instead focus on funding growth and dialing down interest expenses. Based on the debt load and the recent jump in price, I’m going to hold off on Diamond Foods for the time being.
