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It has been a tumultuous few years at Diamond Foods (UNKNOWN: DMND.DL ) as an accounting scandal, unhappy suppliers, and a heavy debt load almost brought it to its knees. Fortunately, the company found some much-needed financing when Oak Tree Capital invested roughly $225 million in May 2012. More importantly, Diamond Foods has tentatively put its accounting transgressions in the rear view mirror with an agreement to settle its outstanding securities litigation. Given this, should investors bet on a solid future for this former growth story?
What's the value?
Diamond Foods has a leading position in the snack foods business, primarily through its Kettle Brands, Pop Secret, and Emerald nut franchises. It also has a significant business in the domestic walnut trade, though that segment has been in decline as contract farmers have increasingly affiliated with competitors, especially those serving the rising demand for nuts in Asia.
In its latest fiscal year, Diamond Foods' top-line contracted 12% as sales in its nuts segment fell sharply due to supply constraints and management's decision to reduce the company's product offerings. On the upside, the company's snack foods segment posted slightly higher sales, fueled by volume gains and a further expansion of its distribution network. More importantly, Diamond Foods' profitability improved markedly, with adjusted EBITDA up 28.2% to $101.7 million, benefiting from a better gross margin and cost savings initiatives that were begun during the company's crisis period.
Despite strong consumer demand for walnuts, which has likely been boosted by anecdotal reports of positive health benefits, Diamond Foods' future is in the snack foods business, a segment that generated a 34.7% gross margin in the 2013 fiscal year (compared to a 12.5% gross margin for its nuts segment.) However, the company's focus puts it in head-to-head competition with other small food companies that have better funding and recent growth trends, like Hain Celestial Group (NASDAQ: HAIN ) and Boulder Brands (UNKNOWN: BDBD.DL ) .
The larger of the two, Hain Celestial, has been on a tear lately, driving a 64% increase in sales over the past four years through increased distribution points and the successful promotion of its "Healthy Way of Life" mission. A portion of the top-line gains can also be attributed to its active acquisition strategy, which has increased its international exposure and added to its overall product diversity. While the grocery segment accounts for the majority of its sales base, roughly 74%, Hain Celestial also has a solid position in the snack foods segment, including its Garden of Eatin' and Terra brands.
In its latest fiscal year, Hain Celestial continued its double-digit growth. Revenues were up 25.9%, aided by international acquisitions that brought a variety of grocery product lines, as well as a presence in the baby food product arena. Despite lower operating margins in its international segments, Hain Celestial's larger scale is providing efficiency in its production operations and leading to higher overall profitability. More importantly, the improved profitability is providing solid operating cash flow that allows it to reinvest in product innovation and marketing, ultimately benefiting all of its segments.
Meanwhile, Boulder Brands has also followed a strong growth trajectory lately. It has evolved from a niche manufacturer of butter spreads to a diversified food company focused on gluten-free, plant-based, and heart-healthy areas. The company's turning point was its July 2012 acquisition of Udi's Healthy Foods for roughly $126.9 million, which brought it a platform to expand into a variety of product areas, including snack and frozen foods. While Boulder Brands' legacy Smart Balance segment continues to struggle with declining sales, its natural foods segment has been generating double-digit sales gains as it rides the rising consumer interest in organic and health food alternatives. This is evidenced by the FDA's recent decision to standardize labeling in the gluten-free area.
The bottom line
Diamond Foods has certainly enhanced its financial and operating position over the past two years, but it remains a work-in-process as it seeks to lower its debt load, mend relationships in its walnut supply chain, and improve its internal controls. In contrast, Hain Celestial and Boulder Brands have been creating value for shareholders through both internal product development and acquisitions, while using debt judiciously to fill out their portfolios. As such, investors should leave Diamond Foods on the bench in favor of its growing competitors.
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