This Beaten-Down Stock Could Gain 50%
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 materialize.
If that happens, then the stock could plummet.
#-ad_banner-#But investors had few such concerns about Diamond Foods (Nasdaq: DMND). 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 EBITDA margins, setting the stage for 63% earnings per share (EPS) 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: PG). 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 profit margins would continue to expand rapidly.
Investors eventually warmed up to this major acquisition, pushing shares from $60 to more than $90 by October 2011. After all, the acquisition was expected to help boost EPS to new heights with analysts projecting $3.50 a share by fiscal 2013.
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 2012.
The CEO 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 balance sheet 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% dilution to current shareholders, but puts Diamond back on much firmer financial footing.
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 pink sheets 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 fiscal year 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 pricing.
That puts this stock’s value at less than eight times projected 2013 profits. As a point of reference, Kellogg Co. (NYSE: K), General Mills (NYSE: GIS) and Kraft (NYSE: KFT) 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.
P.S. My colleague Paul Tracy recently found another stock that has fallen out of favor with investors. It holds more than $48 billion in cash on its books, and is literally giving back billions to shareholders… yet it trades for a ridiculously cheap price. He’s so confident this stock will go up that he’s made it one of his Top 10 Forever Stocks. You can find out about all 10 of his favorite stocks, including several names and ticker symbols, by clicking here.