This Turnaround Company Could Enrich Investors

Diamond Foods is making a comeback from an accounting scandal that left them in a tough position.

Mar 12, 2014 at 10:46PM

Diamond Foods (NASDAQ:DMND) has an extremely high debt load and has recently been accused of accounting fraud. This may not be an investment for the faint of heart, but if you believe in second chances then this company could reward you handsomely.

Jumping right into it
In November 2011 Diamond was accused in several lawsuits (which have since been consolidated into one) of misleading investors and making false statements regarding financial results and operations, specifically in reference to payments made to walnut growers .

The results of this accounting scandal have been ugly; Diamond is expected to pay $11 million in cash and issue 4.45 million shares of their stock into a recovery funds, as well as pay $5 million to the Securities and Exchange Commission .

In fiscal 2013, Diamond lost $163 million on sales of $864 million. The loss was built by $180 million worth of impairments due to the lawsuit and issues related to the lawsuit .

The first quarter of the current fiscal year offered more of the same, as Diamond piled up losses of $42 million on sales of $235 million. Again, losses were due to $45.5 million worth of impairments due to the lawsuit and related issues.

Indebtedness issues
Diamond's debt issues began in 2010, when the company increased its debt fivefold to acquire Kettle Foods . Then, in the midst of the accounting lawsuits, it agreed to take an investment from Oaktree Capital Management L.P. in order to restructure its balance sheet . This deal added $225 million worth of debt at a rate of 12%.

The interest expense of nearly $58 million for last fiscal year represented an interest rate on long term debt of nearly 10%, as well as 7% of total sales.

Where to go from here
Diamond appears to be heading in the right direction. In February, the company completed a debt restructuring. This included a new issuance of $230 million worth of 7% notes to replace the Oaktree loan and a replacement of the $415 million term loan . The debt restructuring should help improve margins as interest expense will be drastically lowered.

Along with the restructuring, time should help heal Diamond from its legal woes. Once Diamond completes settlements and related issues, there is plenty of promise left.

Diamond operates a snacks segment with brands including Kettle chips and Pop Secret popcorn, as well as a nuts section including Emerald and Diamond of California brands. The company had been averaging over 10.5% top line growth each year for the nine years prior to 2013, when revenues dropped 12% from 2012 .

The decrease in sales in 2013 was caused by decrease in net segment sales. This trend continued in the first quarter of 2014 as the snacks segment grew sales by 1.2% from the same period a year prior, and nut sales fell 17% from the same period a year prior . Decreases in nut sales were due to lack of supply of walnuts and the relaunching of the Emerald brand. The company hopes these issues are behind them, and their outlook was positive after the release of first quarter earnings.

Current valuation
Due to negative earnings, price to earnings ratio cannot be computed. Instead, we will take a look at Diamond's price to sales ratio, which stands at 0.8. This compares favorably to larger competitors General Mills (NYSE:GIS) and Kellogg (NYSE:K), selling at 1.9 and 1.5 times sales, respectively.

General Mills and Kellogg both have a much larger and more diversified stable of brands which helps them have more consistency than their smaller counterpart, Diamond. They have both consistently had profit margins around 10% over the last ten years.

Continued turnaround
As the turnaround continues and operations get back to normal, Diamond will be able to acquire and diversify into more brands and grow margins to a regular rate for the industry. A turnaround such as this does not happen overnight or even over a year for that matter, and Diamond is still in the beginning stages of the process.

Investing now, ahead of second quarter earnings that will still be plagued by legal issues, could give you a favorable position as this company smoothens operations moving forward in the coming years.

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Jacob Meredith and clients of Appalachian Capital Group, LLC have no positions in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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