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Shares of Diamond Foods (DMND) have seen a sharp pullback after the company reported its fourth quarter results on Monday after the close.

The soft outlook for the first quarter of 2014 scared off many investors who send shares some 10% lower on the back of the announcements. The much anticipated recovery is taking longer than expected as the company is experiencing some bumps on the road.

I remain on the sidelines, not anticipating a smooth and swift recovery of the business in the coming quarters.

Fourth Quarter Results

Diamond Foods generated fourth quarter revenues of $199.8 million, down 10.8% on the year before, but ahead of consensus estimates of $192.5 million. The company reported a net loss of $147.1 million on the back of a range of incidental and one-time charges.

Diamond took $96.1 million in charges related to the settlement of the securities class action lawsuit. Other charges included a $36 million impairment charge on Kettle and a $20.6 million charge related to a change in the fair value of Oaktree warrant liabilities.

Non-GAAP earnings came in at $2.3 million, as non-GAAP earnings totaled $0.09 per share. On average, analysts were looking for non-GAAP losses of $0.03 per share.

CEO Brian Driscroll commented on the fourth quarter performance, "Our cost savings and net price realization strategies helped us generate improved results for the fourth quarter and fiscal year. We remain intently focused on these productivity initiatives to help support our future brand innovation and to address potential commodity headwinds in fiscal 2014. In addition, we believe the proposed settlement of the securities class action lawsuit is an important first step in our ability to normalize our capital structure."

Looking Into The Results

As mentioned above, Diamond reported poor revenue results entirely driven by the poor performance of the nuts business. While snack revenues were up by some 3.3% to $117.1 million, nuts sales fell by 25.2% to $82.7 million.

Despite the drop in revenues, actual gross margins in dollar were increasing, resulting in a spectacular 770 basis point improvement in gross margins which increasing towards 26.6% of total revenues. These positive developments were behind the reported increase in non-GAAP earnings and adjusted EBITDA.

Valuation

Diamond Foods ended its fourth quarter with hardly any cash, although the firm has access to $74.5 million in cash from a revolving line of credit. Total debt outstanding was $585 million, resulting in a rather high net debt position.

Revenues for the fiscal year of 2013 came in at $864.0 million, down 12.0% on the year before. Diamonds reported a GAAP loss of $163.2 million, while adjusted EBITDA rose to $101.7 million.

Trading around $21 per share, the market values Diamond Foods at $475 million, or the total enterprise at some $1.06 billion. This values the firm at roughly 1.2 times annual revenues and roughly 10 times adjusted EBITDA.

Given the financial difficulties of the firm, Diamond does not pay a dividend at the moment.

Some Historical Perspective

For a long time Diamond Foods has been a boring food company with shares trading around their twenties. Shares gradually rose to highs of $90 in 2011 as investors were wildly enthusiastic about the deal to acquire Pringles. Shares ended that year around $30 per share on well documented dubious payments to walnut growers.

Shares actually fell further to levels around $15 at the end of 2012 and spring of this year, before a recovery send shares back to the $20-$25 price range.

Between the fiscal 2010 and 2013, Diamond Foods increased its annual revenues by a cumulative 27% to $864 million. The company has been reporting large GAAP losses for 2012 and 2013 on the back of the clean-up efforts.

Investment Thesis

Diamond's shares have been hit hard after shares plunged two years ago on payments to walnut farmers. This eventually put too much stress on the company, which consequently called off the announced acquisition of Pringles from Procter & Gamble (NYSE:PG). In the end Kellogg (NYSE:K) snooped up the Pringles assets.

Instead, the company is now left with snacks under the Kettle brand and Pop Secret brands. The struggling nuts business is selling under the Diamond of California and Emerald brand. Snacks are faring relatively well reporting gross margins of 36.1% for the year, while nuts are still underperforming, reporting gross margins of just 13.0%.

While the company made some progress, the disappointing outlook for first quarter sales and contribution headwinds are outright disappointing. Note that the company plans to take higher costs on the Emerald re-launch, while it will suffer from lower walnut supply. Despite these short term headwinds, Diamond still expects improvements for the full year given the realization of benefits from its multi-year turnarounds strategy.

Diamond is still cleaning up the mess and is facing some bumps on the road to recovery at the moment. While snacks are doing actually just fine, more work is needed in the nuts business which is still bleeding and putting pressure on the leverage ratios and valuation of the entire firm.

While the planned restructuring could result in solid GAAP earnings going forwards, as Diamond focuses on margin recovery, there might definitely be some upside ahead. If Diamond Foods can recover to a revenue base of $1 billion, while showing continued margin expansion, shares might have quite some upside.

Yet I am not one of those hoping for better times. While I could imagine shares going back to $30-$40 in a few year's time on the back of operational improvements and deleveraging, I think execution risks are definitely still existing. Diamond should focus on deleveraging as it currently pays effective interest rates of over 10% making debt extremely expensive.

I remain on the sidelines, expecting that the much anticipated recovery will occur at a slower pace than many have hoped for.

Source: Diamonds Foods - Nuts Business Drives Investors Nuts