This Small Cap Food Business is Still Quite Expensive

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Diamond Foods (NASDAQ: DMND) has experienced the gain of as much as 8% to hit $17.50 per share after reporting impressive earnings results, which beat both top line and bottom line estimates. In the first quarter 2013, investment guru Mario Gabelli bought 278,000 shares of the company. Let’s take a close look to determine whether or not we should invest in Diamond Foods after its impressive third quarter earnings results as well.

Third quarter results beat estimates

Diamond Foods, incorporated in 2005, is the owner of several packaged food brands including Emerald, Kettle Brand, Pop Secret and Diamond of California. Diamond Foods derived most of its revenue, $605.8 million, or 61.7% of the total revenue, from snacks, while the culinary and retail in-shell sales were nearly $293 million. The company's two biggest customers were Wal-Mart Stores and Costco Wholesale, representing 18% and 12% of the total revenue in 2012, respectively.

In the third quarter of 2013, Diamond Foods generated more than $184.9 million in revenue, lower than the revenue of $207.7 million in the same period last year. Diamond Foods managed to narrow down the loss, from $(44) million in the third quarter last year to $(15.6) million this year. The non-GAAP earnings per share was $0.05, handily beating Wall Street’s estimate loss of $(0.17) per share. Looking forward, Diamond Foods expected a further decline in revenue, driven primarily by the nuts business.

But high leverage and high valuation

What makes me worry about Diamond Foods is its high leverage. As of April 2013, it had $309 million in equity, only $7 million in cash and around $575 million in both long and short-term debt. Furthermore, Diamond Foods booked a huge amount in its goodwill and intangibles, of $830 million. Consequently, Diamond Foods has negative tangible equity of $(521) million. At $18.80 per share, Diamond Foods is worth nearly $418 million. The market values Diamond Foods at as high as 20 times its EV/EBITDA.

EV/EBITDA stands for Enterprise Value/Earnings Before Interest, Taxes, Depreciation and Amortization. This ratio shows the relationship between the market value adjusted with cash and leverage position, and the cash flow position of the company. The lower the ratio, the cheaper the stock.

ConAgra Foods is better with Ralcorp’s acquisition

Interestingly, Diamond Foods is valued the most expensively compared to its much bigger peers ConAgra Foods (NYSE: CAG) and Mondelez International (NASDAQ: MDLZ). ConAgra Foods, at $33.60 per share, is worth around $14 billion on the market. The market values ConAgra at a bit lower EV multiple, at 16.6. In the beginning of the year, ConAgra has completed the acquisition of Ralcorp, which it has pursued for several years.

This acquisition is really a strategic addition to ConAgra’s food portfolio, creating the largest private food brand company in North America. Moreover, ConAgra could take advantage of Ralcorp’s relationship with major retailers, quick service restaurants and food distributors in North America. After the acquisition, ConAgra would have more balanced portfolio with 43% in Branded segment, while the Private Label and Commercial/Foodservice segments accounted for 25% and 32% of the total revenue, respectively. For the full year 2013, ConAgra expected to generate around $2.15 per share in EPS, including Ralcorp’s expected contribution.

Mondelez could be a much better buy

Mondelez is the global leader in several food categories including Biscuits, Powdered Beverages, Candy and Chocolate. Its main playground are emerging markets. In the first quarter 2013, Mondelez experienced double-digit growth in China, Brazil and India. However, because of the capacity constraints in some markets and expected lower coffee pricing, Mondelez estimated that its 2013 revenue growth would stay in the low end of 5%-7%. The operating EPS would be around $1.55-$1.60 per share.

Activist investor Nelson Peltz is getting more bullish on Mondelez. In the middle of May, he doubled his stake in Mondelez, holding around 40.3 million shares in the company. As he also invested in PepsiCo, and many people speculated that he might push for the merger of PepsiCo’s Frito-Lay business and Mondelez. Indeed, if that happens, the combined business would have the most dominating global position in the world’s food industry. Mondelez, at $29.30 per share, is worth $52.30 billion. The market values Mondelez the cheapest among the three companies, at only 13.5 times EV/EBITDA.

My Foolish take

With the current loss-generating situation, a weak balance sheet and high valuation, I do not think Diamond Foods is a good stock for investors now. I like Mondelez the most due to its global leading positions in fast-growing markets, as well as a relatively low valuation in the food industry.

Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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