Diamond Foods Stock Play a Little Nutty

NEW YORK ( TheStreet) - As Diamond Foods ( DMND) tries to resolve a potentially crippling set of accounting, debt and regulatory issues, investors shouldn't try to nibble on the snack food-seller's shares until the company gets its financial house in order.

After reports Wednesday of a possible minority investment by private equity -- and a forbearance agreement with lenders like Bank of America ( BAC) -- stock investors won't have much chance to make a thoughtful investment in Diamond Foods, even if the company's food brands continue to show strong value.
Diamond Foods may have choked on Pringles

That's because a lender agreement to keep all debts from coming due immediately expires only a week after the company is expected to finally file earnings for the fiscal third and fourth quarters, giving investors little visibility into Diamond Foods true health.

On Wednesday, Diamond Foods said that through June 18 it's agreed to new terms with its lenders that will avoid making all of the company's loans due immediately. If those loans were to be called as a result of covenant breaches, the company could face a default and possible fire sale.

As part of the forbearance agreement, Diamond Foods will pay a higher interest rate on its credit line, suspend its dividend and work with a newly hired financial advisor Dean Bradley Osborne to raise capital and ensure its balance sheet meet covenants. Separately, the Wall Street Journal reported that private equity firms KKR ( KKR) and TPG Capital were considering a possible minority investment in what's known as a "PIPE" deal.

Earlier in March, Diamond Foods said it had received an extension to file its earnings results for the quarters ended on Oct. 31 and Jan. 31 by June 11. The company also said it received a "non-compliance" notice from the Nasdaq, but will continue to be listed and traded as it works to file earnings.

That news is good for Diamond Foods, even if stock investors don't cheer because it gives three months time for the company to repair its finances, as it resolves accounting issues and a Securities and Exchange Commission investigation.

"It would certainly seem in the lenders' best interest to provide Diamond Foods ample cushion to continue operating as a going concern while it assesses its longer-term alternatives," wrote Janney Capital Markets analyst Mitchell Pinheiro in a note assessing the forbearance. "We found the report to be somewhat surprising, as the thought of further dilution seems unnecessary on the surface. Perhaps this is nothing more than public posturing signaling to potential strategic buyers that the board has other options and there will be no asset fire sale." Pinheiro cut his Diamond Foods price target to $23 from $25 and rates shares "neutral."

Diamond Foods continues to garner a near $40 a share price target, according to consensus analyst estimates polled by Bloomberg, as many focus on the sum of the company's parts. Pinheiro calculated that the San Francisco-based maker of Kettle Brand potato chips, Emerald Nuts and Pop Secret popcorn could be worth $31 a share in a breakup. D.A. Davidson & Co. analyst Timothy Ramey reiterated his $44 a share price target and "buy" rating in a Mar. 13 note highlighting sales growth. He estimated that its Kettle potato chips division could be worth up to $900 million in a sale.

But equity investors are taking a different stance. After February audit committee findings confirmed accountancy issues, stock investors slammed Diamond Foods, causing a near 40% Feb. 8 stock drop. After Wednesday's optimistic news, Diamond Foods shares fell over 7% to $23.76 in afternoon trading.

Content on this page requires a newer version of Adobe Flash Player.

Get Adobe Flash player

The problem for investors is that Diamond Foods still needs to file earnings after an audit committee found that the company didn't properly account for Emerald Nuts walnuts supplier payments. Since those filings are expected just a week before lender forbearance expires, it gives public investors little time to weigh the company's financial results against its precarious situation. Meanwhile, the prospect of a dilutive private equity investment or a lender-initiated firesale remain.

How bad could the restatements be? The lender forbearance will stand so long as Diamond Foods net loss for the quarter ended on April 30 doesn't exceed $13 million, including accounting adjustments, according to a March 21 filing with the SEC. The agreement allows for up to $4.3 million in write-offs and $5 million in other expense, according to the filing.

Diamond Foods, KKR and TPG Capital declined to comment for this story.

In February, Diamond Foods said it will likely recognize an additional $40 million in 2011 expense, pushing down earnings to a point where analysts expect that the company will breach its loan covenants. Separately, a source familiar with the matter said that Diamond Foods was in breach of certain covenants in its credit agreement prior to the forbearance.

According to those loans, a covenant breach can trigger a default, placing the company's fate in the hands of lender agreements like Wednesday's forbearance. Investors won't know the full scope of how the company's accountancy issues impact its creditor standing until the company files its earnings and re-files reports from past quarters.

The loans were raised by Diamond Foods to fund acquisitions. In 2008, Diamond Foods bought Pop Secret for $190 million and it bought Kettle Foods from Lion Capital in 2010. Last year, the company made its boldest-ever acquisition attempt in a $2.35 billion acquisition of popular potato chip brand Pringles from Procter & Gamble ( PG). After its accountancy issues, that deal has been terminated, with Procter & Gamble selling the business to Kellogg's ( K) for $2.7 billion.

With Pringles added, Diamond Foods had expected to earn up to $4 in earnings per share by 2015 on greater than $2.4 billion in revenue. However, in light of accountancy issues, the now looming prospect of a covenant breach and still pending earnings filings, the acquisition attempt may have been too aggressive for Diamond Foods.

When Diamond Foods cut the cash and stock deal, it simultaneously arranged a $500 million term loan and a $550 million revolving credit facility with its bankers for the purpose of funding the acquisition, and the $850 million in debt that came with it. Those loans were subject to covenants that forced the company to have financial leverage below 4.5 times earnings before interest taxes depreciation and amortization (EBITDA) into 2013 and less thereafter. After entering the deal, Diamond Foods said it expected leverage of less than 4 times EBITDA. However, in reaction to audit committee findings, Jefferies analyst Thilo Wrede said that the accounting change would cause a breach of the covenant, signaling a thin margin for error.

The big question is whether three months will give Diamond Foods the time or flexibility needed to put the company back on the right side of creditors, as shareholder lawsuits and regulatory investigations linger. Meanwhile, the company is facing management change after its former Chief Executive Michael Mendes and Chief Financial Officer Steven Neil abruptly exited the firm in February and were replaced by former Del Monte Foods CEO Rick Wolford and Alix Partners Managing Director Michael Murphy, respectively.

Since none of those questions are expected to be answered in full until mid-June, there's little reason for stock investors to take a bite on Diamond Foods. Meanwhile, there are many other interesting developments in the snack foods market for investors to pick over.

On Wednesday, Kraft Foods ( KFT) said that when it spins its snack foods division later in 2012, the Oreo's cookies and Cadbury Crème Eggs-selling unit will be called Mondelez International. Meanwhile, Kellogg's shares surged in February when Procter & Gamble sold Pringles to the cereals and snacks giant, in a deal that it expects will add up to 10 cents in 2012 earnings per share.

In recent months, Ralcorp ( RAH) completed a spin of its Post cereals business, an acquisition of Sara Lee's ( SLE) refrigerated doughs business and spurned a $94 a share takeover from ConAgra Foods ( CAG).

For more on snacks investments, see 7 stocks to benefit from lower corn prices and top yielding food and beverage stocks.

-- Written by Antoine Gara in New York