We have maintained our long-term Neutral recommendation on Diamond Foods Inc. (DMND). Diamond Foods is the U.S. leader in the culinary and in-shell nut category with approximately 37% market share.
Diamond Foods is focused on increasing market share by expanding the existing nut product lines and introducing new nut products in the United States and worldwide. Management’s strategic plan is based on providing higher-margin branded nut products at premium price points.
The branding strategy includes a marketing program that is designed to build consumer awareness and customer loyalty through targeted TV advertising, unique packaging and in-store merchandising. Further, management has outlined three main priorities – building the distribution network, expanding the retail channels, especially in the club and mass merchandiser areas, and increasing sales velocity within the existing channels.
Moreover, Diamond Foods’ fourth-quarter 2011 adjusted earnings per share came in at 52 cents, outpacing the Zacks Consensus Estimate of 44 cents and surged 53% from 34 cents per share posted in the year-ago quarter. The improvement was primarily attributable to strong sales and improved margins.
Bolstered by better-than-expected performance, the company also raised its fiscal 2012 earnings guidance to a range of $3.05 to $3.15 per share from $3.00 to $3.10 per share forecasted earlier.
Further, the recent agreement to acquire the Pringles brand from The Procter & Gamble Company (PG) will enhance Diamond’s geographic diversity and is expected to boost its international sales contribution to 49% of total revenue. The acquisition will provide a broader global manufacturing and supply chain platform enabling Diamond Foods to access key growth markets throughout the world.
In addition, Diamond Foods is vertically integrated and has advanced processing capabilities. The company is integrated from direct sourcing and shelling of nuts to processing and packaging of nut products. The vertically integrated business model allows Diamond Foods to quickly react to market trends and exploit new opportunities. Moreover, the company’s nut roasting facilities and patented glazing technologies provide a shelf stable glazed nut for the mass market.
However, Nuts, the primary raw materials of Diamond Foods, are subject to fluctuations in availability and price. Though the company has long-term supply contracts with walnut growers, crop size, quality, and yield fluctuations could cause supply shortages and/or price increases that would negatively impact the company’s profitability.
Besides, Product recalls or concerns with safety may lead consumers to avoid nut products and reduce sales. A significant product recall would reduce sales, especially if the recall is related to walnuts (which account for approximately 60% of sales).
Above all, the company faces intense competition from national and regional competitors, including Planters — owned by Kraft Foods Inc. (KFT) — Blue Diamond Growers, Sunkist, and John B Sanfilippo & Son Inc. (JBSS), which also owns the Fisher Nut Company. The competitors possess strong brands and economies of scale.
Aggressive pricing actions by competitors to gain market share would pressure margins and reduce profitability. Consolidation in the food retailing industry has increased the level of buying power of large discount chains like Wal-Mart Stores Inc. (WMT), and supermarkets. The competition for shelf space has made it difficult for food companies to raise prices.
