Nut and snack food company Diamond Foods (UNKNOWN:DMND.DL) recently settled a lawsuit stemming from an accounting scandal that resulted in the restatement of two years of its financials. On Aug. 21, the stock price surged more than 20% as Wall Street breathed a sigh of relief. However, you may want stay away from this company as an investment, and here are five reasons why.
The accounting mishaps that resulted in these lawsuits stemmed from a control environment that didn't allow for the free flow of information. The control environment didn't ensure that economic transactions got recorded in the proper accounts during the right periods, distorting accounts payable and accrued expenses .
The question here is, does the culture that resulted in this mishap still exist? The executives in charge during the period in question no longer draw a paycheck from the company; however, do employees still feel pressure to distort accounting in other ways?
Investors need to approach Diamond Foods with the assumption that this company carries a higher information risk rating.
Year to date Diamond Foods' revenue declined 12%, stemming from a 23% drop in nut revenue due to a walnut supply shortage . Someone I once knew in the grocery industry said that you can't sell empty shelves. If Diamond Foods can't procure new supplies of walnuts then it could find itself struggling to gain revenue to turn the company around.
Snack volume decrease
Diamond Foods' snack revenue did increase 3% year to date due to price increases; however, it experienced a volume decline of 2% . Diamond Foods will need to profitably boost volume, find new customers, and invest in advertising to offset this. Raising prices could potentially drive volume down to the point where this segment will no longer profit the company.
As of the most recent quarter , Diamond Foods long-term debt to equity ratio stood at a monstrous 187% of stockholder's equity . Year to date operating income only exceeded interest expenses 0.62 times ! Diamond Foods needs to perform the multifaceted feat of increasing revenue to meet interest expenses and refinancing its debt, which could prove difficult given its recent accounting scandal.
Better fish in the sea
While Diamond Foods struggles with the stigma in its accounting department and turnaround efforts, its competitors march forward.
J&J Snack Foods (NASDAQ:JJSF) continues to benefit from its 2012 acquisition of Kim & Scott's Gourmet pretzels . So far in 2013, J&J Snack Foods grew revenue 7% driven by strong growth in pretzel and churros revenue. Free cash flow suffered a bit due to increased capital expenditures; however, over the long term demand for pretzels and churros, as well as the company's strong portfolio of branded frozen beverages, should serve as catalysts for growth.
Snack food rival Snyder's-Lance (NASDAQ:LNCE) also understands pretzel popularity. In October 2012 it purchased Snack Factory, the maker of the Pretzel Crisp line.
Keep in mind that Snyder's-Lance comes with its own set of problems, like weaknesses in private brand revenue , trademark writedowns of potentially valuable brands , and possible disenfranchisement of previous employees. However, Snyder's-Lance shows vast fundamental improvement stemming from the Snack Factory acquisition . Company revenue and free cash flow increased 8% and 262%, respectively, year to date. Pretzel popularity, as well as new variations on its cracker sandwiches introduced this year, will serve as catalysts for possible growth in its top and bottom lines.
Keep an eye out for possible future lawsuits against Diamond Foods related to its accounting scandal. The company will need to solve walnut supply issues and boost snack volume in order to increase operating profitability to better meet interest obligations on its debt. The wise investor would stay on the sidelines until things improve for this company. J&J Snack Foods and Snyder's-Lance serve as better bets, as they capitalize on pretzel popularity and new products, with both free to focus on their business instead of their accounting departments.
William Bias has no position 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.