Diamond Foods (DMND)

TOP CONTRIBUTORS

Thomas Robb

Partensa

SpartysFA

Summary

Diamond Foods is a packaged food company that specializes in processing, marketing and distributing a variety of snack and nut products. The company focuses on building, acquiring and energizing brands and its current portfolio includes: Diamond Culinary Nuts, Emerald Premium Snacks, Pop Secret Microwave Popcorn and Kettle Potato Chips (acquired March 2010). Diamond sells its products to global, national, regional and independent grocery, drug and convenience store chains, as well as to mass merchandisers, club stores and other retail channels.

Competition

Diamond competes with two different types of companies: nut processors and diversified snack manufacturers.

Nut Competitors

Ralcorp owns Post Foods and is a leading supplier of private label foods to the United States. They specialize in dry pasta, cereals, bakery products, snacks, sauces & spreads. The company competes with many of Diamond's culinary products, however they do not have a brand name and demand a smaller profit margin.

Snyder's-Lance owns Snyder's of Hanover and many other brands that produce sandwich crackers, wafers, cookings, popcorn, snack cakes, cheese products and seed & nut products. The seed & nut division creates single serve nut products that are sold near check out counters at a variety of retail locations. The firm competes with Diamond's Emerald brand, but does not carry the premium label.

Sanfilippo (John B.) & Son through its subsidiary Fisher Nuts, manufactures and markets many of the same products that Diamond does. Fisher Nuts is a much smaller company with a market cap of only $127 million and does not have the distribution network nor the diversified product line that Diamond has.

Snack Competitors

Hain Celestial Group Inc offers natural and organic grocery products, including non-dairy beverages and frozen desserts, granolas, granola bars, cereal bars, chocolate, nut butters and nutritional oils, juices, popcorn cakes, cookies, crackers and gluten-free frozen entrees and cereal bars. It also provides snack products, such as potato and vegetable chips, organic tortilla style chips, whole grain chips, and popcorn; and herb tea, green tea, wellness tea, organic tea, specialty black tea, chai, and iced tea. In addition, the company offers personal care products and meat and deli products. Hain competes directly with Diamond's chips and popcorn as well as offering healthier substitutes.

J&J Snack Foods Corp. sells soft pretzels under the brand name SUPERPRETZEL, frozen juice treats and desserts under the Luigi's, Fruit-A-Freeze, Whole Fruit, ICEE, Barq's and Minute Maid brand names and frozen beverage products under the ICEE and Slush Puppie brand. Not a direct competitor, but does compete for consumer discretionary income.

Golden Enterprises, Inc sells potato chips, tortilla chips, corn chips, fried pork skins, baked and fried cheese curls, onion rings and many other snack products. Golden is a very small company and does not have the distribution breadth or brand name to effectively compete with Diamond.

Inventure Foods Inc. sells snack products under the Jamba, T.G.I Friday's and Burger King brands as well as a few other brands. Inventure competes heavily with Kettle Chips in the premium chip market and is a strong threat because of its use of well-known international brands to sell it's products.

Summary

Although the clear industry leader in the snack nut segment, the overall level of competition in the packaged food is high. There are a large number of competitors offering a "commoditized" product. Diamond competes through product differentiation by offering premium brands and creating brand loyalty.

Industry Analysis

Value Chain Analysis

Product Development

New product development occurs through an arrangement with Mattson & Company, an independent food product development firm. Diamond Foods management team works hand and hand with Mattson through the development process. DMND believes the arrangement “enables us to use top-quality talent to develop innovative products quickly, while minimizing product development costs." New product development for the potato chip products occurs internally.^[1]

Processing

The large majority of Diamond Food products are processed and packaged at numerous facilities across North America and Europe. Third parties can be contracted to process and package a portion of DMND products when warranted by demand and specific technical requirements. Diamond Foods popcorn products are the only product line that regularly produces a portion of their products through a third-party.^[2]

Marketing

In the retail space Diamond Foods focuses on building brand awareness, attracting new customers and increasing consumption through product line specific market strategies. Marketing to ingredient/food service customers is focused on trade-oriented activities.^[3] The graphs display revenue growth with advertising expense, and advertising expenses as a percentage of revenue.

Shows DMND's Advertising Expense and Revenues

Distributing

Domestic distribution occurs from five Diamond Food facilities and eight leased warehouses across North America. Internationally Diamond Foods owns a production facility in Norwich, England and leases one in Snetterton, England. The administration and fulfillment of customer orders is handled internally by the sales administration and logistics department. Contract and common carriers ship the majority of Diamond Food products from their production, warehouse, and distribution facilities.^[4]

Porter's 5 Forces

Rivalry among Existing Firms

High: DMND competes against many regional and national snack product providers, some of which are larger and have substantially greater resources. Over the years DMND branded products have been able to gain key market share. In 2010, Diamond Culinary Nuts had a market share approximately ten-times larger than the next largest brand. Emerald attained market share of 10.6%; Pop Secret it the number two national brand and achieved 27.3% market share; and Kettle moved to the number two premium potato chip brand with 3.5% market share of the potato chip market.^[5]

Threat of New Entrants

High: Diamond Foods believes that additional competitors will enter the market as large food companies begin to expand their offerings to directly compete with DMND products.^[6] Outside of food companies expanding into the DMND markets, the snack industry has little barriers to entry and competition could be non-organic to the industry.

Diamond is somewhat insulated from new companies because of a fee in the supermarket industry that requires many suppliers to pay for shelf space. Small companies do not have the cash flow to pay these fees while well established companies such as Diamond can pay for premium and maximum space.

Threat of Substitutes

High: The primary substitute power comes from snack products not offered by Diamond Foods, such as baked goods or candies. As DMND continues to grow and pursue strategic acquisitions, Diamond Foods may enter these substitute markets.

Buyer Power

Medium/High: Although, Diamond Foods has been improving its diversification of buyers in 2010 sales to Wal-Mart stores (Wal-Mart and Sam’s Club) accounted for approximately 17% of sales and sales to Costco Wholesale accounted for 12%. Although, these two retailers may have buyer power over DMND, no other customer accounts for more than 10% of their net sales.^[7] See the graph to see the historical trend of Wal-Mart and Costco as a percentage of net sales. An example of Buyer Power in the snack foods industry is retailers ability to charge producers slotting fees for shelfing space. Diamond Foods fees are taken as a reduction as sales. As the retailer spacce becomes consolidated in touch economic conditions, these fees may increase accordingly. Diamond Foods also markets ingredient nuts under the Diamond of California brand both domestically and internationally to food processors, restraints, bakeries, food service providers and their supplies. These non-retail markets accounted for 16% of net sales in 2010. As the graph illustrates retail sales have become a larger and larger portion of net sales. This trend has been continuous since 2004 when 51% of net sales were to non-retail consumers. This suggests although individual retailer power is being fragmented amongst retail outlets, the group as a whole is becoming more important to Diamond Foods.

Diamond may also be required to pay a "Slotting Fee" to grocery stores. This is a fee to guarantee shelf space in super markets. These fees can range from $25,000 for a new product in a particular region to $250,000 for a established product on a national basis. Kraft is a powerful player in this practice which is why they dominate the consumer staple industry. Stores can also charge promotional, advertising or stocking fees that put more power to the grocers. ^[8]

Diamond uses outside shipping companies so they do not have to depend on grocery store logistics to sell their products. We believe that is a benefit and gives the company more power over its distribution network.

Shows DMND's percentage of Revenues

Supplier Power

Low: Diamond Foods is not materially dependent upon any individual raw-material supplier relationship. An example is the walnut supply which is provided by over 1,700 growers, the majority of which are located in California and have entered in long-term supply contracts.^[9] Most other nut products are obtained on the open-markets both domestically and internationally. No supplier offers a unique product in which DMND food requires.

Note: The pistachio market is dominated by a few key suppliers. Diamond does not produce, process or distribute pistachios and thus less dependent on their suppliers compared to other nut companies.

Business Analysis

Human Resources

Below is a table that summarizes some of the key executives at Diamond Foods, Inc. Included is age, a list of the positions they currently hold at Diamond, previous places of employment, their educational background as well as their current compensation as of Dec. 31, 2010. ^{[10] [11]}

Marketing

Diamond holds the belief that marketing efforts are a key factor of a successful business. They spent $33.0 million in 2010 on advertising. This is a 14.6% increase from $28.8 million in 2009. Looking further back, in 2008 their advertising expenses were $20.5 million, and they increased that by 40.5% for the next year. ^[12]

Product

Diamond Foods, Inc. offers a variety of products to fit different consumer needs. Their main categories include snack, culinary, retail in-shell, international non-retail, and North American ingredient/ food service. Under their snack foods they offer glazed nuts, roasted and mixed nuts, trail mix, microwave popcorn, potato and tortilla chips, as well as some natural products for the produce aisle. The culinary category contains shelled and pegboard nuts, and glazed and harvest reserve premium nuts. A breakdown of the retail in-shell products is various uncracked nuts and mixed nuts. International non-retail products offered are in-shell nuts as well as shelled and processed nuts plus some custom-processed nuts. Similarly in North America for the food service market they offer shelled and processed nuts and custom-processed nut, but they also include glazed nuts. Additionally, each of the product lines allow consumers to choose from “better for you” options. All of Diamond’s products come in an assortment of sizes and packages, ranging from to go packs up to bulk sizes. ^[13]

Price

Diamond's prices are influenced by a number of external factors. Their raw materials include different nuts, corn, potatoes, and other ingredients and all of these are subject to price changes. A few examples of problems that could arise are poor weather, crop diseases, or other various troubles. All of these play a role in the yield of the raw materials and ultimately the price of them. If there is a lower supply and a higher demand then prices will rise. Commodity prices fluctuate which is something that the company cannot control. Diamond currently does not hedge against changes in commodity prices. This means that changing prices in their raw materials can affect the prices of their products or their profitability. ^[14]

Place

Diamond Foods, Inc. distributes their products in North America as well as overseas in England. They use their own distribution facilities across the United States, including set ups in Alabama, California, Indiana, Oregon and Wisconsin. Additionally, in California, Georgia, Illinois, Indiana, New Jersey, Oregon and Wisconsin they use separate leased warehouse and distribution facilities. Also they have their own facilities as well as leased facilities that they use in Canada and Snetterton, England. They market directly to a variety of retail outlets. Mainly they distribute to national grocery stores, mass merchandisers, clubs, convenience stores and drug stores. When products get shipped from Diamond facilities they are usually carried by contract and common carriers, not their own trucks. As far as in store placement is concerned Diamond designs displays and they tend to place these set ups in multiple locations throughout each store. With this type of placement they hope to increase impulse purchase opportunities. ^[15]

Promotion

Diamond puts a lot of effort into promotion by using a consumer targeted marketing campaign in which they utilize a wide variety of techniques. These include television ads on network and cable channels, advertisements in print as well as online, and coupons. In store promotions include bright eye catching shelving and pegboard displays. In order to increase brand awareness they focus on public relations by offering educational publications as well as samples. These methods allow consumers to learn about the benefits and convenience of Diamond products while also being able to test them. Also, they sponsor active lifestyle activities like marathons and other related events. Another facet they employ is they attend trade shows and use trade publication advertising in order to promote the food service products. ^[16]

Recent Emerald Nut Commercials [1]

Strategy Analysis

DMND invests in:

• Brands
• Innovation
• Operational infrastructure
• People

Their strategy is to continue to expand operating margin by growing their branded consumer product portfolio, while maintaining a strict discipline on growth, which will facilitate achievement of greater operating leverage in the future.

Their goal is to continue to grow revenues by increasing market share in the snack category, while strengthening their position as the number one marketer and distributor of culinary nuts. In addition, they intend to expand profit margins by increasing sales of higher-margin retail products at a faster rate than non-retail products and by reducing costs, Increase market share in the snack industry, Improve Margins, Expand and improve position in distribution channels, and Pursue additional growth opportunities.

Strategy Framework

Nature of Product

DMND offers unique products or services for particular market niches or offering non differentiated products at low prices.

Geographical Diversification

DMND sells products to global, national, regional and independent grocery, drug and convenience store chains, as well as to mass merchandisers, club stores and other retail channels.

North America

• DMND markets consumer products through sales personnel directly to large national grocery, mass merchandiser, club, convenience stores and drug store chains. The sales department also oversees their broker and distributor network. DMND consolidated their brokerage network into one national broker in 2010. The distributor network carries Kettle brand potato chips to grocery, convenience and natural food stores in various parts of the United States.

• DMND distributes products from production facilities in Alabama, California, Indiana, Oregon, Wisconsin, and Norwich, England, and from leased warehouse and distribution facilities in California, Georgia, Illinois, Indiana, New Jersey, Oregon, Wisconsin, Canada and Snetterton, England. Sales administration and logistics departments manage the administration and fulfillment of customer orders. The majority of products are shipped from production, warehouse and distribution facilities by contract and common carriers.

United Kingdom

• DMND markets potato chip products through sales personnel directly to national grocery, co-op and impulse store chains.

Industry Diversification

Diamond has five product lines

Snacks

• Emerald products include roasted, glazed and flavored nuts, trail mixes, seeds, dried fruit and similar offerings packaged in innovative resealable containers
• Microwave popcorn products are offered in a variety of traditional flavors, as well as a “better-for-you” product offering featuring 100-calorie packs.
• Kettle Foods, a leading premium potato chip company. Kettle products are offered in a variety of flavors and sizes.
• Snack products are typically available in grocery store snack, natural and produce aisles, mass merchandisers, club stores, convenience stores, drug stores, natural food stores and other places where snacks are sold.

Culinary

• Culinary nuts under the Diamond of California brand in grocery store baking aisles and produce aisles and through mass merchandisers and club stores.
• Culinary nuts are marketed to individuals who prepare meals or baked goods at home and who value fresh, high-quality products.

Retail In-Shell

• In-shell nuts under the Diamond of California brand, primarily during the winter holiday season
• Typically available in grocery store produce sections, mass merchandisers and club stores.

International Non-Retail

• Market ingredient nuts internationally under the Diamond of California brand to food processors, restaurants, bakeries and food service companies and their suppliers
• In-shell nuts under the Diamond of California brand, primarily during the winter holiday season.

North American Ingredient/ Food Service

• Ingredient and food service nuts under the Diamond of California brand to food processors, restaurants, bakeries and food service companies and their suppliers

SWOT Analysis

Strengths

All three snack brands outpaced category growth and achieved record market share in U.S. grocery stores. This performance demonstrates the ability of DMND brands to generate sales and profits while using shelf space efficiently for retail partners.

Culinary Nuts

• Expanded distribution in grocery and mass merchandise channels, as well as the execution of innovative promotional support.

Emerald

• Products introduced in 2009, such as peanuts, 100 calorie packs, and Cinnamon Roast almonds have experienced increasing sales volume as a result of a full year of sales.
• New distribution channels for several core items in the mass merchandise and drug channels and initiated the launch of the new Breakfast on the Go in grocery stores.

Pop Secret

• Expanded distribution in grocery and mass merchandise channels, and new product introductions.
• DMND continues to invest in innovation and marketing support and is committed to continuing to build the Pop Secret brand.

Kettle

• Increased scale and relevance in the snack category.planning for expanding capacity in the U.S. production facilities
• U.S. growth has been driven by item velocity and distribution gains as the brand expanded into new regions and channels
• Kettle gained distribution of single-serve items in the deli sections of the grocery and mass merchandise channels and launched new, all-natural snacking tortilla chips called Tias!
• In the United Kingdom, DMND launched Kettle Ridge Crisps and expanded the distribution of their multi-pack offering.

Weaknesses

• Acquired firm Kettle Foods, as a private company, may not have had proper accounting controls set in place prior to the acquisition.

• Debt increased from 115,085 in 2009 to 556,100 in 2010.

Opportunities

Increase market share in the snack industry:

• DMND plans to promote the broad line of snack products by aggressively investing in creative advertising, marketing and promotional programs.
• Continued investments in national advertising campaigns will help differentiate their products and improve competitive position.
• National consolidation of retailers has created a need for distribution efficiencies.
• DMND intends to gain additional market share in the snack market by exploiting national brand and distribution systems, and by cross promoting nut, popcorn, potato and tortilla chip products.

Improve margins:

• Optimize product mix as a greater proportion of sales in the future will be higher-margin products.
• Invest in capital improvements for projects that lower costs and optimize the location, function and utilization of processing, storage and distribution facilities.
• Leverage scale in operating expenses by expanding existing sales channels, such as mass merchandisers and club stores, and introduce snack products in new distribution channels.

Pursue additional growth opportunities:

• Strategic acquisitions
• Strategic alliances

Threats

• Disruption of production facilities would significantly decrease production, which could increase cost of sales and reduce net sales and income from operations.

• Changes in the food industry, including changing dietary trends and consumer preferences, could reduce demand for products. DMND's growth is largely dependent on the snack market, where consumer preferences are particularly unpredictable. To address consumer preferences, DMND invests significant resources in research and development of new products.

• Transportation costs, including fuel and labor, also represent a significant portion of the cost of products, because third party trucks and rail companies collect raw materials and deliver products. These costs fluctuate significantly over time and can affect profitability.

• Raw materials are subject to fluctuations in availability and price. The availability, size, quality and cost of raw materials for the production of products, including walnuts, pecans, peanuts, cashews, almonds, other nuts, corn, potatoes, ingredients and processing oils, are subject to risks inherent to farming, such as crop size, quality and yield fluctuations caused by poor weather and growing conditions, pest and disease problems, and other factors beyond their control. Currently, DMND does not hedge against changes in nut, corn or potato commodity prices.

• Large inventories of raw nut material. If there is a decline in the prices of finished product, a significant portion of inventories could decline in value, and this might result in a write-down of inventory.

Financial Analysis

The below information analyzes the financial performance of the company focusing on profitability, efficiency and leverage & solvency. The charts on the right give a heat-map view of the changes in key ratios. They are designed to show green being the best relative ratio and red being the worst relative ratio over the years shown.

Profitability

Looking at their Return on Assets (ROA) and Return on Equity (ROCE) you can tell that their profitability over the last five years have been trending upwards except for the most current year, 2010. In 2010, Diamond acquired Kettle foods which added new inventory and intangible assets which caused asset turnover to fall and profitability to decline. Return on Invested Capital (ROIC) is similar to ROA and includes the entire capital base of the company.

Return on Assets

Return on Assets is calculated by multiplying “Profit Margin for ROA” and “Asset Turnover.” As you can tell, profit margin has been steadily increasing for the past five years. This has been driven by the company’s push into brand name retail products that carry a higher profit margin. This includes the introduction of their Emerald Nuts Brand and the acquisition of Pop Secret and Kettle Chips. The chart below shows how the profit margin has nearly doubled in five years.

As described below in “Efficiency,” the main reason for the decrease in asset turnover is their non-current asset turnover and fixed asset turnover. After the acquisition, Goodwill and Other-Intangible assets accounted for over 60% of total assets. These are not necessarily producing assets and thus weigh on the ROA.

Return on Common Equity

Profit margin for ROCE has the same trend as the ROA Margin - it has been in a steady uptrend for the past 5 years. ROCE also shares the same Asset Turnover as ROA. What sets this metric apart is the inclusion of capital structure leverage in the calculation. ROCE was able to outperform ROA because the leverage of the company was increased after the acquisition of Kettle Chips. Although it can make the company more risky, leverage usually increases return for shareholders as long as the operating earnings can pay the interest expense.

Return on Invested Capital

Return on Invested Capital is a metric designed to calculate the return on the entire capital base (not just equity). The graph shows that the increasing amount of equity and debt has been decreasing the overall return of the company. The company is expecting the growth of their brands and the saving in synergies to propel their income forward and increase their ROIC overtime. Their most recent report (2010) does not include a full year of Kettle earnings, however it does include all of their assets and resulting increase in equity. 2011 should show a small bounce to its mean purely because of a full year of reporting.

Efficiency

Current assets have been managed very well and have caused their days short term financing they require to shrink from 90 in 2007 to 57 in 2010. Days Accounts Payable have been increasing and shows that they have been using their suppliers and a portion of their financing needs. At the same time, their Days Receivables have been shrinking which shows that they have been receiving money from their customers quicker. Days Inventory has also had a positive trend since 2007, but reversed and went higher in 2010. When digging deeper, you can see that two of their inventory segments improved, but Raw Materials went much higher after the Kettle acquisition.

The graph on the right also shows the breakdown in turnover between current assets and non-current assets. It confirms the two facts that we have previously stated – that current assets are improving while fixed and non- current assets are being turned slower.

Solvency And Leverage

All of the ratios on the chart to the right show that Diamond’s Solvency has been decreasing in recent years. Although some of the ratios seem dangerous, there a couple of things to consider. One is that current operating results do not include a full year of Kettle earnings. Therefore, interesting coverage ratio will increase as earnings increase. Assets will most likely return a more normal level as facilities are consolidated and unnecessary inventory is eliminated. Long term, the added growth and potential for synergies will increase assets and liabilities, thus relieving pressure off those ratios. The company also has a $600 million credit line that it can use to pay interest payments if unexpected events happen and it can’t pay its debt.

References

1. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
2. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
3. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
4. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
5. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
6. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
7. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
8. ↑ http://www.forbes.com/forbes/2002/0415/130.html
9. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
10. ↑ http://www.diamondfoods.com/about/executive_team.php
11. ↑ http://finance.yahoo.com/q/pr?s=DMND+Profile
12. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NzIzOTd8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1
13. ↑ http://finance.yahoo.com/q/pr?s=DMND+Profile
14. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NzIzOTd8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1
15. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NzIzOTd8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1
16. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NzIzOTd8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1
17. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
18. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
19. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
20. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1
21. ↑ http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDA1OTY5fENoaWxkSUQ9NDE0OTM4fFR5cGU9MQ==&t=1

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