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On Dec 30, we upgraded packaged food company, Diamond Foods Inc. (DMND - Analyst Report) to Outperform based on its improved prospects.

Why the Upgrade?

We remain impressed with Diamond Foods’ continued focus on improvise merchandise margins and effective cost management, which has enabled it to post better-than-expected bottom-line results for the third consecutive quarter. Over the past four quarters, Diamond Foods has delivered an average surprise of 79.91%.

The company’s first-quarter fiscal 2014 earnings of 18 cents per share rose considerably from the Zacks Consensus Estimate of 14 cents. However, it declined 25% year over year due to continued challenges in walnut supply and higher Emerald re-launch costs.

Looking ahead, Diamond Foods expects adjusted EBITDA and earnings to improve year over year through the rest of fiscal 2014, primarily benefiting from the implementation of its ongoing multi-year turnaround initiatives. Further, the company remains on track to achieve its targeted cost savings of $35 - $40 million through fiscal 2013 and 2014, driven by improved procurement and manufacturing output as well as continued effort to lower costs.

Following the better-than-expected earnings result and impressive guidance, the Zacks Consensus Estimate for fiscal 2014 and 2015 has been witnessing an upward trend over the last 30 days. The Zacks Consensus Estimate for fiscal 2014 has gone up 4.9% to 43 cents per share, while for fiscal 2015 it has moved up significantly (19.4%) to 86 cents per share.

What is the cause for the strong positive bias on the company? Apart from robust first-quarter results, Diamond Foods’ growth story looks compelling given the continued gains from its vertically integrated business model that allows it to quickly react to the market trends and exploit new opportunities as well as advanced processing capabilities.

On the other hand, we note that Diamond Foods’ turnaround strategies such as improving price realization, lowering underperforming SKUs, and reducing dependency on discounts have started producing desirable results, as evident from improved margins in the trailing three quarters. Moreover, we expect this Zacks Rank #3 (Hold) company’s future results to depict more sustained growth of its brands, arising from product innovation and differentiation, improved cost structure and rebuilding of healthy relationships with walnut suppliers.

Other Stocks to Consider

Better-ranked stocks in the food industry include ConAgra Foods Inc. (CAG - Analyst Report), The Hain Celestial Group Inc. (HAIN - Analyst Report) and Green Mountain Coffee Roasters Inc. (GMCR - Analyst Report). All these stocks carry a Zacks Rank #2 (Buy).

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