Diamond Foods Update – That’s What Makes a Market

Diamond Foods ($DMND) put out a press release this morning updating some of their businesses and the status of their financial restatements.   I have no position in DMND at the moment, but I have been involved in the stock and this saga previously.   I talk regularly with two very smart colleagues about this stock, and what I found interesting was our disagreement this morning.

When I read the press release, I came away with a bearish slant  – the mention of capital structure and of rising walnut costs didn’t seem to bode well.   One of my colleagues agreed with me, and the other was adamant that this release was extremely bullish, suggesting strong performance of the underlying businesses, and that the restatement timeline may be accelerated.

Here’s what stood out to me:

“To assist Diamond in assessing our capital structure and evaluating ways to strengthen the balance sheet, the Company has retained Dean Bradley Osborne Partners LLC as its financial advisor”

When you talk about capital structure, you’re usually talking about, first and foremost, managing the balance of debt and equity on your balance sheet.  If you don’t have enough debt, you might recapitalize to lever up (ie, issue more debt and use the proceeds to pay a dividend or repurchase stock).   If you have too much debt, you might try to figure out ways to reduce leverage.   It’s pretty clear to me that DMND is not in the “leveraging up” stage – they’ll be looking to raise cash to reduce debt.   They can do this in a number of likely ways:  1) sell common stock, 1a) sell preferred stock  2) sell one of their business, 3) sell the whole company.   I think that number 3 is the least likely, given the still unresolved accounting issues.   In fact, that makes number 1 less likely too: how do you sell stock when you don’t have clean financials?  Maybe they’ll figure out all the accounting shenanigans, then address their capital structure.

Next up:

“Extensive efforts are underway to reset the Company’s walnut activities and to restore and strengthen Diamond’s relationships with growers. Increased global demand for walnuts has driven pricing to record levels of at least 35 percent higher than for last year’s crop. Diamond, as it refocuses on its walnut supply, intends to be competitive in its walnut sourcing activities, and expects its walnut-related cost of sales to rise in line with current pricing trends. Diamond is taking pricing action to address this cost issue.”

Walnut costs are going up big time, and Diamond will be raising prices to compensate.  I think it’s pretty tough to spin this part bullishly.

Now the good news:

Brand YoY
Growth
Category YoY
Growth
Market Share
Change
Emerald +29% +3% + 200 basis points
Pop Secret +6% +2% +110 basis points
Kettle U.S. +8% +1% + 20 basis points
Diamond of California +7% +8% – 30 basis points

Sources: Nielsen U.S. Food, Drug and Mass dollar sales for 12-week period ended February 18, 2012. All comparisons are to the same measured period in the prior year.

“”Despite the challenges we have faced over the past several months, our brands continue to perform well and we believe the steps we are taking will best position Diamond for the future,” continued Rick Wolford.”

Indeed – the brand performance is solid, and there is value hidden in there somewhere.  How much value is the billion dollar question.

I found the market price reaction to the DMND press release, as well as the sharp division between the intelligent people I talk to who are familiar with this story to be pretty interesting.   As the saying goes: “That’s what makes a market.”

One other item of note:  this stock is very hard to borrow and has a large short base already, which may be affecting the price action.

-KD

 

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