Market Overview

Diamond Foods Looks Set To Squeeze Higher

Last Wednesday, Diamond Foods (NASDAQ: DMND) announced the results of an ongoing internal accounting investigation which centered on certain payments the company made to walnut growers. In the months leading up to the resolution of the audit committee's investigation, DMND shares had lost well over half their value, falling from an all-time high of $96.00 in September to roughly $37.00 before the findings of the investigation were released.

Long stockholders were hoping that the accounting review would not lead to a financial restatement and this opinion was buoyed by some analysts. Unfortunately for DMND shareholders, the findings of the audit committee were extremely damaging and the company will be forced to restate its financial results for 2010 and 2011.

The company's press release stated that "over the course of the last three months, the Audit Committee has carefully reviewed the accounting treatment of certain payments to walnut growers. The Audit Committee has concluded that a "continuity" payment made to growers in August 2010 of approximately $20 million and a "momentum" payment made to growers in September 2011 of approximately $60 million were not accounted for in the correct periods, and the Audit Committee identified material weaknesses in the Company's internal control over financial reporting."

In addition, the company announced that its CEO and CFO had been placed on administrative leave and that Diamond had commenced searches for permanent replacements. Diamond Director Rick Wolford was named Acting President and Chief Executive Officer and Michael Murphy of Alix Partners LLP was named Acting Chief Financial Officer.

Not surprisingly, DMND shares plunged on the news. Not only would their be a restatement, but the two top officers at the company were essentially fired as a result of the accounting shenanigans - in sum, it was worse than the market had anticipated.

When DMND began trading again after the announcement, the shares opened up down roughly 37%. The final damage done to the stock price as a result of the accounting investigation has been more than substantial - a 72% decline since late September. The consequences of the shoddy accounting practices at Diamond, however, go beyond just a battered stock price.

On Wednesday, February 15, Proctor & Gamble (NYSE: PG) announced that it was selling its Pringles chip brand to Kellog (NYSE: K) for $2.7 billion and that its previous deal with Diamond Foods to buy the brand had been nullified. Back in April 2011, Diamond and Proctor & Gamble had announced a definitive agreement to merge the Pringles business into Diamond Foods in a transaction which was valued at roughly $2.35 billion at the time.

The acquisition would have given Diamond the second largest U.S. snack food business behind Pepsico (NYSE: PEP) and the announcement provided a strong catalyst for the stock price. Diamond shares rose from roughly $60.00 on the day of the announcement in April to above $90.00 in September prior to the accounting inquiry. As DMND's stock price plunged and the company became embroiled in turmoil, however, it looked increasingly less likely that the transaction would be completed.

On Wednesday, this view was confirmed as Proctor & Gamble and Diamond mutually nullified the deal which was expected to encounter financing difficulties. Kellog (K) swooped in to buy Pringles in a deal that will substantially bolster the company's snack lineup. Shareholders showed their approval for the move by Kellog, pushing up the stock better than 5% on Wednesday.

A strange thing happened in DMND as well - the stock stopped going down and actually rallied on heavy volume. With the announcement that the Pringles deal would not be completed, it finally seems as if all of the bad news surrounding Diamond Foods may be out in the open. This could be a positive catalyst for the stock.

Furthermore, DMND has an absolutely massive short interest with roughly 52% of its float sold short. There is a very high likelihood that these short-sellers will begin covering their bets in the coming weeks and this could set off a powerful short covering rally in the name.

On Thursday, DMND is up another 3.24% on heavier than usual volume. While the accounting revelations at the company and the abrupt dismissal of the CEO and CFO certainly are cause for concern, it would appear that the market has sufficiently punished the stock and DMND could be set to run higher in the near-term on the back of heavy short covering.

Posted-In: Long Ideas News Management Intraday Update Movers Trading Ideas Best of Benzinga

 

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