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A Chemistry PhD employed as a researcher in the pharmaceutical industry since 2000, I have been an active equity investor since 2006.
  • Legal tail risk creates a compelling value in Imperial Sugar 0 comments
    Jan 18, 2010 11:42 PM | about stocks: IPSU
    Imperial Sugar (NASDAQ:IPSU) is a sugar refiner operating two refineries in Louisiana and Georgia.  The last several years have been tumultuous for Imperial, but things are are starting to look up for them if they can just get past a few lawsuits...

    Let's start in 2006.  Sugar prices were way up after Katrina and IPSU earned $4.45/share.  They paid $0.24 in regular dividends plus a $3 special dividend.

    In 2007 they earned $3.43 per share and paid $2.78 in regular and special dividends.  You can see how those are some great numbers for a company currently trading at just over $17.

    But then there was 2008...  in February the larger of their two refineries (roughly 60% of their total capacity) had a major explosion.  That refinery was shut down and didn't start producing again until July 2009 (it's still ramping up for full production levels this spring).  With all of that lost capacity, plus the costs of dealing with the explosion, the company lost $1.81 and $2.03 per share for the years ended September 2008 and 2009, respectively.

    Now for the good part.  After a rough two years, Imperial's turnaround plans are coming to fruition.  Since the time of the accident, IPSU has received insurance payments totaling $300 million which were used to rebuild their refinery.  But because there had been no settlement with the insurance company, those payments were just advances on whatever the final settlement would be.  So as the refinery was repaired, its new value showed up as an asset, while most of the $300 million was on the balance sheet as a liability (not all though; for reasons that aren't clear to me, some of the advances were recognized as gains).  In December, Imperial and its insurer reached an official settlement for $345 million.  The insurance companies advances are no longer a liability and Imperial will record a pre-tax gain of $278 million for the quarter (that's over $23 per share!).

    So we have $23 of (pre-tax) earnings per share for a company that's trading around $17/share.  I feel confident that there is a large upside to the shares based on this fact alone.  Then consider the fact that the damaged refinery is approaching full production levels and that sugar prices are far higher now than they were in the wildly profitable year after Katrina.  In 2006 prices averaged roughly 14 cents/lb compared to the current price of ~28 cents/lb.  I don't make stock price predictions, but consider that a P/E of 10 on 2006 earnings would give a price of roughly $44.

    Then there is the balance sheet.  Imperial has $115 million in cash currently, and the insurance settlement mentioned above includes one additional payment of $45 million due this month.  That gives them $13.33 per share in cash, and once the insurance liabilities mentioned above are wiped out, their tangible book value per share will be $30.  So that gives you another reference point for what a fair value for the shares might be.

    What's the catch?  You don't find obviously, substantially undervalued shares without some problem that's scaring people off.  The catch here is that 14 workers were killed in the explosion mentioned above and many others were wounded.  There are 45 lawsuits pending against Imperial relating to the accident.  Imperial management has stated that they believe their workers' compensation and liability insurance should be sufficient to cover any losses resulting from those lawsuits.  On the other hand, this Forbes article states that the workers' attorneys are seeking $500 million in damages and that Imperial has only $100 million in insurance. (The article also has good information on the joint ventures that Imperial is looking to for growth.) 

    So how is this likely to play out for Imperial?  I looked around the websites of law firms based in Georgia, and believe it or not, workers in Georgia are not allowed to sue their employers for pain and suffering or wrongful death.  And workers' compensation insurance covers unlimited payments for medical care, so it seems very likely to me that Imperial management is correct that they will owe nothing aside from their insurance deductible of $0.5 million.  There is a chance of some surprise outcome from the lawsuits that could significantly hurt Imperial.  But the favorable outcome looks more likely, and the share price appreciation that would accompany it could be large. 

    Your judgment of the likely hood of those outcomes, and their consequences for Imperial's share price, will determine your estimate of IPSU's fair value.  To me it looks considerably higher than $17.  I am long IPSU.

    Disclosure: Long IPSU
    Stocks: IPSU
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