Diamond Foods: $35 Price Target

Feb.15.12 | About: Diamond Foods, (DMND)

Using a historical PE method, here's a quick model showing Diamond Foods' (NASDAQ:DMND) valuation. 2011 and 2010 earnings are corrected here, and the goal was just to get a normalized 2012 number. Same effective gross margins were used as in 2011, and the historic PE (2007-2009, normal years) was used to extrapolate a new value. The ideal PE may actually be higher given that Kettle Chips and Pop Secret may be brands more in line with holdings of Synder Lance (with a PE of ~40), but I chose to keep estimates conservative here considering all of the headwinds.

Debt costs are bumped up 2% to account for covenant violations. Given an improving EBITDA picture in 2012, this perhaps should not be considered a permanent effect, as Diamond should be able to negotiate rates back down in the future.

Revenue growth is estimated at 10% annually here. 5% or even 0% may be more realistic, and given that, such an adjustment to 0% brings both price targets down about $5.

Perhaps the most aggressive assumptions I make are removal of acquisition costs and a return of SG&A and Sales down to an average of 2010 and 2011 levels. I do this because my gut says some of grower payment remissions may have occurred in SG&A and were perhaps one-offs, and under new management, the marketing budget might take a small hit in favor of taking care of near term cash flow issues.

One time charges related to increased legal are not included, but can be deducted from market cap of equity at the reader's discretion. As well, issues related to falling supply as a result of early grower contract terminations are not included. There are a few possible impact implications from this, and a possible model improvement would be to model the impact of paying higher prices for walnuts on cost of sales. Likely, Diamond would try to increase the price of end-product to capture the difference in price given it had to pay closer to market rates for walnuts near-term. Another point to consider is that these news reports focus on a minority of growers, so the effect may be relatively immaterial to results. Considering the markup in a package of nuts at the grocer level, sustaining these price increases might only have a negligible impact on end demand.

Also not included is the impact of a possible termination fee ($60M) from P&G on the Pringles merger. The impact of this at worst should be about $2.80/share.

From there we arrive at a number a little shy of $31/share. There's headroom in this estimate as increased debt costs for 2012E model year should be a short term issue. As well, the bulk of Diamond's debt is in a $350M term loan that pays of $40M/year, so the fundamentals and leverage should only improve each year.

The simple model can be seen here. Since the original post, a DCF model is the main focus and yields a slightly higher result in the $39 range. I'd consider the DCF a bit more reliable, as it takes into account specifics of dilution effect, term loan facility payoff, etc. Upon averaging the two model results, a $35-36 valuation is appropriate. Enjoy and adapt as you please to factor in your own assumptions.

Disclosure: I am long DMND.