Whenever a company decides to pursue a
growth-through-acquisition strategy, investors grow concerned. The
payoff can be rapid growth and investors are certainly happy
whenever that happens, but the risks are significant. Execution
must be perfect, or hoped-for synergies will simply fail to
If that happens, then the stock could plummet.
But investors had few such concerns about
Diamond Foods (Nasdaq:
. The purveyor of gourmet nuts and snack foods pulled off a string
of acquisitions in recent years, successfully integrating brands
such as Pop Secret and Kettle Chips to augment its internal Diamond
and Emerald nuts brands.
Those deals helped to boost sales sharply, from $571 million in
fiscal (July) 2009 to $966 million in fiscal 2011. Equally
important, the acquired brands helped boost
margins, setting the stage for 63%
earnings per share (
growth in fiscal 2011 to $2.22 a share.
And then management got greedy.
Pleased with those deals, Diamond announced plans in April 2011
to acquire the Pringles brand from
Procter & Gamble (NYSE:
. At the time, the company was valued at $1.35 billion, but planned
to pay $2.35 billion to swallow this big fish.
Prior to the closing of the Pringles deal, Diamond kept
delivering extremely good quarterly results. By last October,
analysts at D.A. Davidson gushed that "We've followed the food
sector for 25 years and the growth Diamond is generating is among
the best we've ever seen." They predicted that
margins would continue to expand rapidly.
Investors eventually warmed up to this major
from $60 to more than $90 by October 2011. After all, the
acquisition was expected to help boost
to new heights with analysts projecting $3.50 a share by fiscal
But management's plans eventually crumbled. Less than a year
later, this stock has fallen 80% to a recent $18. So is now the
time to buy?
Let's take a further look...
The troubles began in November when Diamond's board of directors
looked into concerns that the company may have improperly accounted
for payments to walnut growers back in 2010. That was enough to
delay the Pringles deal for a few quarters -- into the spring of
Fast-forward to February 2012, and Diamond's
committee released findings that the company had overstated
in each of the prior two fiscal years.
and the chief financial officer were given their walking papers.
The Pringles deal was officially dead. Adding insult, the financial
restatements meant that the company was now outside of debt
covenants and cash would need to be raised -- pronto.
In late May, those
concerns were put to rest as Diamond received a $225 million
capital injection from Oaktree Investments. The deal brings the
potential of up to 17%
to current shareholders, but puts Diamond back on much firmer
At this point, the company's major challenge is to get current
with its financial reports and defend itself against a few lawsuits
(which look to be of the nuisance variety and not legitimate legal
challenges). It's crucial that those filings come soon, as Nasdaq
could temporarily push this stock to the
if Diamond doesn't catch up with its filings soon.
Shares can surely go lower for a while if Diamond drags its
feet. But if and when those filings emerge, this stock could
quickly vault from the upper teens into the mid-$20s.
Putting it together
Looking ahead, Diamond plans to increase its focus on core brands,
especially in the walnut and peanut businesses. Right now, the
walnut business looks challenging, with a 40% year-over-year spike
in prices paid to walnut growers. Coupled with the
investment-related dilution, EPS forecasts are now more modest.
Instead of the $2.50 a share in earnings that analysts had been
expecting in the current
that ends this month, per share profits are likely to be closer to
$1.70. And analysts say EPS could rebound to around $2.25 a share
in fiscal 2013, in part due to a return to more typical walnut
That puts this stock's value at less than eight times projected
2013 profits. As a point of reference,
Kellogg Co. (NYSE:
General Mills (NYSE:
all trade for 13-15 times projected 2013 profits. As Diamond Foods
moves away from its recent screw-ups, the forward multiple will
likely revert back to the peer group, implying at last 50% upside
for this beaten-down stock.
Risks to Consider:
Much of this rebound is predicated on a pullback in walnut
prices later this year, and if that fails to happen, then shares
may take a few years to move back toward my target of $25-$30.
Action to Take -->
The delayed filings tell you that this stock still has risk. If you
can handle the potential for further near-term weakness, then you
should be amply rewarded down the road once all of these headwinds
have fully abated.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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