Diamond Foods (Nasdaq:DMND) is trying to get back on solid footing after a series of self-inflicted wounds threatened the survival (or at least the independence) of the company not so long ago. While rehashing the company's accounting issues and strategic missteps is beyond the scope of this article, the fact remains that Diamond Foods is still in the middle of its clean-up operations. Valuing these shares is tricky given all the factors at work, but they do appear undervalued provided that the company can continue to repair its margins and clean up its capital structure.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

A Tough Quarter Comes In A Little Better Than Feared
It would be hard to call Diamond's fiscal third quarter a strong result, but it was better than most analysts expected. Revenue fell 11%, which was actually better than the 15% decline reflected in the averaging of sell-side estimates. Snack revenue improved almost 2% despite a nearly 6% decline in volume, while the nut business saw revenue contract 23% on a very large volume decline (40%) tied to deliberate SKU reductions.

As the SKU reduction in nuts is motivated at least in part by eliminating unprofitable products, the margin improvement in the quarter was a positive development. Gross margin improved by almost seven points overall, with almost eight points of improvement in snacks and a two and a half point improvement in nuts. It's worth noting, though, that nut gross margin is still less than one-quarter that of the snacks business. Diamond reported a modest operating loss for the quarter and would have nearly broken even without a warrant liability expense recognition.

SEE: Understanding The Income Statement 

Still Running The Business, And That Keeps The Window Of Opportunity Open
One of the things I find interesting and encouraging about Diamond Foods is that the company remains committed to running this business along relatively sound business principles even with the remaining uncertainties of the turnaround effort.

When companies get into trouble, they often cut back on advertising and product support, which has the long-term consequence of choking revenue growth. Diamond is continuing to support its brands, though, and while the nearly 6% volume decline this quarter in snacks was not great, the company is still staying in the game from a market share perspective.

It's also important to remember that Diamond competes with some strong rivals that hold significant share in their respective markets. PepsiCo (NYSE:PEP) holds very significant share in the chips market, while ConAgra (NYSE:CAG) controls a large portion of the popcorn market. While there have been some shifts in volume market share, Diamond's dollar market share is doing alright, which is consistent with management pursuing more of a premium positioning for many of its snack products. Given the emphasis that others including Kellogg (NYSE:K), Mondelez (Nasdaq:MDLZ), and Campbell Soup (NYSE:CPB) have placed on growing their snack business, though, Diamond cannot afford to let up and that could represent some downside to operating margin leverage in the near term.

A Solid Hire For The CFO Position, But Ample Uncertainties Remain
Diamond Foods shareholders should be pleased with the company's hiring of Raymond Silcock as CFO of the company. Mr. Silcock has significant experience in the food industry, and would seem to have a particularly strong record with turnaround situations that ultimately end in the sale of the business.

Whether or not Diamond is thinking about a potential long-term sales transaction, there's plenty to do in the short term. The company still needs to improve its nut-buying operations, as well as complete the SKU restructuring in nuts. Diamond will also eventually have to do something about its capital structure and balance sheet – management chose not to refinance its $225 million loan from Oaktree Capital (which carries a 12% coupon) due to a lack of shareholder-friendly options, but finding a good solution here is important as this represents pretty expensive capital.

The Bottom Line
If Diamond can work through this turnaround and resolve its issues with the SEC and shareholder litigation, there is a pretty good collection of snack food brands to consider. While I would not advocate buying these shares with an eye towards an eventual takeover, I would acknowledge that plenty of packaged food companies are shopping for brands these days.

SEE: 5 Must-Have Metrics For Value Investors

Valuing Diamond Foods right now is quite tricky. The large net debt position virtually wipes out the company's long-term cash flow-based value, and EBITDA is likewise too depressed right now for EV/EBITDA to be helpful. EV/sales does suggest value here relative to other snack food companies like Lance (Nasdaq:LNCE) and more direct rivals like ConAgra. By no means do I think Diamond Foods should trade at parity with its peer group, but I do believe these shares are undervalued relative to the progress that management has made in turning around the business.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Investing Basics

    Evaluating Paid Investing Newsletters

    Investopedia explains: There are many different newsletters available, and investors must decide which is most appropriate for their investing style.
  2. Investing Basics

    Are You Investing Or Gambling?

    We look at ways in which gambling creeps into trading, and what may drive an individual to trade - or gamble - in the first place.
  3. Active Trading

    Investing Seasonally In The Corn Market

    Each month can bring new growth opportunities, if you know where the right investment seeds are.
  4. Professionals

    The Best Financial Modeling Courses for Investment Bankers

    Obtain information, both general and comparative, about the best available financial modeling courses for individuals pursuing a career in investment banking.
  5. Investing

    Where the Price is Right for Dividends

    There are two broad schools of thought for equity income investing: The first pays the highest dividend yields and the second focuses on healthy yields.
  6. Economics

    Investing Opportunities as Central Banks Diverge

    After the Paris attacks investors are focusing on central bank policy and its potential for divergence: tightened by the Fed while the ECB pursues easing.
  7. Stock Analysis

    The Biggest Risks of Investing in Pfizer Stock

    Learn the biggest potential risks that may affect the price of Pfizer's stock, complete with a fundamental analysis and review of other external factors.
  8. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  9. Technical Indicators

    Using Pivot Points For Predictions

    Learn one of the most common methods of finding support and resistance levels.
  10. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  1. Where can you buy NetSpend reload packs?

    You can only purchase NetSpend reload packs at Giant Eagle, Albertsons, Roundy's and Pathmark supermarkets. NetSpend cards ... Read Full Answer >>
  2. What does low working capital say about a company's financial prospects?

    When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
  3. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
  4. Can a company's working capital turnover ratio be negative?

    A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
  5. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  6. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>

You May Also Like

Trading Center