Imperial Sugar: Buy for Value, Hold for Growth

| About: Imperial Sugar (IPSU)

I wrote a recent instablog about Imperial Sugar (NASDAQ:IPSU), outlining the investment thesis covering the past few years of its history, up to the present. Highlights of that article:

  1. IPSU is trading at under $16.50/share;
  2. IPSU will record a one-time pre-tax gain from an insurance settlement of over $23/share this quarter;
  3. After that gain, their net tangible book value will be roughly $30/share;
  4. Between 2005 and 2007, IPSU paid out over $2.50/share every year in dividends and special dividends;
  5. A refinery explosion in early 2008 shut down ~60% of their capacity, leading to losses in '08 and '09, but the damaged refinery will be back to full capacity within the next few months.

All of these facts are very favorable for Imperial. What's holding the share price down? They are currently being sued for deaths and injuries resulting from the refinery explosion. Due to the nature of Georgia's worker's compensation laws, it is very likely that these lawsuits will be thrown out or settled at negligible cost to Imperial. All of the details can be found in the original instablog.

The reason to buy Imperial is the value outlined above. The reason to hold on to the shares is the growth strategy I'm going to outline below.

For the purposes of this article, I'm working with the assumption that Imperial gets past the lawsuits at no significant cost. Obviously, there is a significant chance of a large share price pop just based on the book value and earnings expectations outlined above (Imperial announces earnings the morning of Feb. 5th). But Imperial is also moving the company in a promising new direction. Sugar refining is capital intensive, low margin, and very sensitive to changes in the price of raw and refined sugar, and energy. To improve their profitability going forward, Imperial has focused their own operations on higher margin consumer products, while developing three joint ventures to provide new markets and growth to the business.

The first joint venture I will cover is Wholesome Sweeteners, an organic sweeteners (honey, agave syrup, fair trade sugars, etc.) business started in 2001 with Edward Billington & Son, a UK based food company. Organic sweeteners have significantly higher margins than conventional sugar, the organic market is growing fast, and Wholesome is the largest company in this space. Between 2005 and 2007, Wholesome Sweeteners grew sales at roughly 30% per year. I haven't been able to find data for 2008, but sales grew 16% in 2009. At present, Imperial owns 50% of Wholesome Sweeteners, but they have the option to purchase the remainder from Billington in the second half of their 2010 fiscal year.

The second joint venture is called Comercializadora Santos Imperial (NYSE:CSI), and it is a 50-50 partnership with the Mexican sugar refiner Ingenios Santos S.A. de CV. CSI is primarily in the business of marketing Ingenios Santos' sugar in Mexico, but it is also seeking to add other Mexican refiners to supply sugar for its marketing operations.

Furthermore, in times where there is a sugar supply imbalance between Mexico and the US, CSI will facilitate the import/export of sugar between Imperial and Ingenios Santos to take advantage of those supply imbalances.

The third joint venture, LSR, is a 3-way split between Imperial, Cargill and a Louisiana sugar growers cooperative. Imperial's contribution to the venture is some land adjacent to their existing Louisiana refinery, plus $6 million for upgrades at that refinery, which will eventually become part of the joint venture. Cargill will construct a large, new, state-of-the-art sugar refinery on the site. Imperial will be 1/3 owner and will purchase sugar from the refinery on long-term contracts. This arrangement should reduce Imperial's exposure to commodity price fluctuations and allow them to concentrate on their marketing efforts.

All of these joint ventures, combined with the moves Imperial is making within its own operations, suggest they are actively pushing to become a more stable, growth-oriented, higher margin business. Wholesome Sweeteners is an easy move up in growth and margin. CSI and Imperial's marketing operations are also pushing hard in that direction. Reading Imperial's literature, you get the impression that they are trying to build a high-value brand-name consumer staples business.

My first thought on this strategy was, "how are you going to do that with a completely commodity product?" But then I thought about Clorox. Bleach is a commodity chemical, generally sodium hypochlorite dissolved in water, and it's cheap as dirt. Clorox built a great brand, got great distribution, and provided value-added formulations (think Clorox bathroom cleaner, detergent, disinfecting wipes, etc.). They're an 8 billion dollar consumer staples giant built on a commodity.

What is Imperial doing to build their consumer staples company? They're building the brand with new ad campaigns. They're expanding distribution-- here in New England the only sugar brand I had ever seen was Domino, but in the last few months I've seen Imperial sugar in Costco (they also had Wholesome Sweeteners products) and Walgreens. And most importantly for this plan to work, they're developing value-added formulations and packaging.

Here's a sample: Imperial brand sugar shakers (e.g., cinnamon & sugar for sprinkling on toast), Baker's Supreme brand frosting mix, liquid sugar for adding to iced tea or coffee, brown sugar prepackaged into individually sealed 1/4-cup measures (if you've ever had brown sugar turn into a brick on you, you understand the value here). As Imperial establishes these products in the market, they will continue to develop novel sugar-based goods to establish themselves as the 'Kleenex', the 'Heinz', the 'Clorox', of sugar.

So you can see how this strategy might work out and provide substantial growth for Imperial over the next several years. It won't be easy, but it's a good vision. All they have to do is execute...

Buy Imperial for the value. Hold it for the growth.

Disclosure: Author holds a long position in IPSU