Description
Short Thesis
Diamond Foods is up close to 50% this year with a TTM valuation of 13x EBITDA and 24x P/E. Given the strong competition not only from other branded companies but also from private label and the discretionary nature of their products, this is a short that is certainly priced for perfection.
Business:
Diamond Foods, originally a member owned walnut co-operative which was converted to a corporation in 2005, is a branded nut company that has recently expanded into popcorn with an acquisition of Pop Secret from General Mills for $190MM. They sell in-shell and ingredient nuts under the Diamond of California brand and snack products under Emerald and Pop Secret brands.
Short thesis
- Valuation is priced for perfection
o Using the high end of estimates and annualizing for the calendar year; the company is trading at 21x forward P/E and 11.5x EV/EBITDA
o Packaged food companies are trading at a forward P/E of 14-16x and EBITDA of 9-10x; arguably expensive as a group in the current environment
o The company bought Pop Secret for approximately 8x trailing EBITDA and 7.5x Forward EBITDA which would value the rest of the business at 15x Trailing EBITDA
- Growth should be more difficult to come by
o The two main categories (nuts and popcorn) are mature categories and growth can only come by increasing share (which they have done) and pricing (which they have done); we believe that they realized this and made the acquisition of Pop-Secret
o In terms of penetration, they are already well distributed nationally and at mass merchants. It will be more costly to expand distribution into other areas like convenience stores which is their target
o The company had increased prices this year and last year and is unlikely to continue to gain this benefit given these are high priced discretionary purchases.
- Margin increases are in the 8th or 9th inning
o They will spend more on marketing and advertising to buy more market share in an already mature and competitive category (popcorn)
o Much of the margin increase over the last several years has been due to a product mix shift to the snack category which carry higher gross margins; in Fiscal 2005 – the commodity (ingredient) lower margin product was about 50% of sales and by next year it will be 20% of sales
- Highly competitive mature markets with larger and deeper pocketed competitors
o Planters dominates the snack nuts category with 36% share, private label is at 32% and Emerald is at 6%
o Orville Redenbacher has a 42%, Pop-Secret has 25% share, and private label has 15% share in the microwave popcorn category
o Diamond is the market leader with 30% share in culinary nuts while private label is at 23% and Planters is at 7.1%
- High priced discretionary purchases will be tough in this highest sales season
o Demand for in-shell and culinary products are typically highest during Sept-December; arguably this will be very difficult months for a discretionary purchase and the move to private label will likely persist
- Potential commodity and international sales risks
o The company does not hedge on commodity costs. The agreement with growers on the nut side requires the company to purchase all the output from an orchard and therefore there is a risk of an inventory writedown should there be a downturn in volumes
o With the dollar strengthening, international sales become more difficult; this represents approximately 16% of proforma sales
Valuation
- There is significant operating leverage should the company’s sales slow down and it has to rely on increased promotions to maintain volumes
- It is not inconceivable that the following happens on a calendar yr basis:
|
Sales
|
|
650
|
|
EBIT
|
6.50%
|
42.25
|
|
D&A
|
|
8.5
|
|
EBITDA
|
|
50.75
|
|
|
|
|
Multiple
|
|
8.0x
|
|
EV
|
|
406
|
|
Debt
|
|
190
|
|
Cash
|
|
49
|
|
MKt Value
|
|
265
|
|
Shares Out
|
16.3
|
|
Price/Share
|
$16.27
|
Catalyst
- High priced discretionary purchases hurt volumes and thus sales and margins
- The company has seen major retailers place smaller inventory orders which is not a good sign
- Nielson data starting to show weakness in category and strengthening private label growth
- Pricing likely to come down in line with commodity prices
- They are starting to have collection issues with some international customers