Description

Imperial Sugar Company (Ticker: IPSU; recent share price of $13.75) is a refined sugar producer and distributor whose shares we value at $7 - $10 each and recommend short selling. The Company trades at a huge premium to its recently sold Holly Sugar subsidiary based on 2004 and YTD 2005 annualized cash flow multiples. Not only is the Company expensive, but also it is struggling with declining margins because of a narrowing spread between prices of raw and refined sugar and rising energy prices. As a sign of its struggles, Imperial Sugar announced this week that it would be laying off 20% of its corporate staff. The Company’s second largest shareholder agrees with our assessment of the Company. Schultze Asset Management revised a $17/share bid for the Company in February 2005 to $10.50/share in September 2005. In addition, the $10.50/share bid was prior to the November 2005 special dividend of $2.50/share. Pro forma for the dividend, Schultze’s bid would be $8/share.


Background

Refining sugar is a cyclical commodity business. A downturn in the cycle and too much debt caused Imperial Sugar to file for bankruptcy in early 2001. After emerging, the Company sold assets and took advantage of a favorable turn in the cycle to pay off substantially all of its debt. This process was the focus of the previous VIC write-up in late 2003. However, after a peak year in fiscal 2004 (ending 9/30/04), the business has been struggling and reported negative EBITDA in its most recent quarter.

In May 2005, Schultze Asset Management made public its $17/share bid for the 85% of the Company it did not already own. The shares promptly traded up to $16/share following the announcement. The Company eventually granted Schultze access to confidential information in order to firm its bid. After three months of due diligence, Schultze determined the Company was worth only $10.50/share and revised its bid to this level. The shares fell below $12 but then recovered to nearly $14 as the Board rejected the bid. Given the business fundamentals, we do not understand why. Also, given that IPSU has been for sale for some time, it would seem that there are no buyers other than Schultze.

Just after the Board rejected Schultze’s bid, the Company finalized a sale of its Holly Sugar subsidiary for $54 million. In late October, the Company announced a special dividend of $2.50 per share using proceeds from the sale. Announcement of the special dividend and “improved industry dynamics” sent the shares to almost $17/share. After the dividend, the shares once again fell below $13 but then recovered to trade around $14, the level at which they currently trade. Therefore, the shares are trading at the same level post-dividend as they were before the dividend announcement despite the Company’s having $2.50 per share less cash. We don’t see any “improved industry dynamics” that justify a 20% higher value to the Company.

The environment for the Company has done nothing but get worse. Natural gas has nearly doubled in price since Schultze Asset Management’s $17/share bid. Prices for natural gas are up a further 10-15% since the $10.50/share bid. While refined sugar prices on the spot market are up 35% in the last twelve months, raw sugar prices are up almost 50%. This tightening of the spread between refined and raw sugar means tightening margins for Imperial Sugar. In addition, we believe the industry is undergoing a secular decline as tariffs on and subsidies for sugar markets in developed countries are lowered over time.


Capitalization Profile

Recent common stock price $13.75
52 week range $10.25 to $20.50
Shares outstanding 10.6 million
Equity market capitalization $145 million
Cash $21 million (post Holly sale, pension payment and dividend)
Assets for Sale and Investments $7 million
Debt $7 million
Pension Obligation $81 million
Enterprise Value $125 million
Enterprise Value w/ Pension Obligation $206 million


Valuation Analysis

We believe the best way to analyze the value of Imperial Sugar is its absolute trading multiples. However, good benchmarks come from the multiples at which the Holly Sugar subsidiary was sold. Imperial’s reported and ex-Holly pro forma metrics can be found in Imperial Sugar’s 8k filed September 22, 2005. We have adjusted Imperial Sugar’s ex-Holly pro forma metrics for $3.7 million of SG&A savings from pensions and shared services. As part of our analysis, we have assumed “pension expense” of 8.5% of pension obligations in order to normalize for what is an unusually large obligation.

The multiples from the sale of Holly are as follows:

EV/EBITDA (3Q05 Annualized) 6.7x
EV/EBITDA-CapEx (3Q05 Annualized) 12.0x
EV+Pension/EBITDA+Pension (3Q05 Ann.) 7.4x
EV/EBITDA (2004) 3.8x
EV/EBITDA-CapEx (2004) 5.5x
EV+Pension/EBITDA+Pension (2004) 4.4x

Imperial’s pro forma metrics are as follows ($ in millions):

EBITDA (3Q05 Annualized) 4.7
EBITDA-CapEx (3Q05 Annualized) (6.7)
EBITDA+Pension (3Q05 Annualized) 11.6
EBITDA (2004) 27.3
EBITDA-CapEx (2004) 13.4
EBITDA+Pension (2004) 34.2

Imperial’s pro forma multiples at its current share price:

EV/EBITDA (3Q05 Annualized) 26.3x
EV/EBITDA-CapEx (3Q05 Annualized) -18.6x
EV+Pension/EBITDA+Pension (3Q05 Ann.) 17.7x
EV/EBITDA (2004) 4.6x
EV/EBITDA-CapEx (2004) 9.3x
EV+Pension/EBITDA+Pension (2004) 6.0x


Imperial’s implied value per share using Holly multiples:

EV/EBITDA (3Q05 Annualized) $ 4.96
EV/EBITDA-CapEx (3Q05 Annualized) (5.67)
EV+Pension/EBITDA+Pension (3Q05 Ann.) 2.39
EV/EBITDA (2004) 11.81
EV/EBITDA-CapEx (2004) 8.90
EV+Pension/EBITDA+Pension (2004) 8.65

Median Value per Share $ 6.81
Average Value per Share
(2004 Multiple Only) 9.79

Given a poor outlook for the business, however, we believe these valuations are high. Yet, we have included the average value per share based on 2004 multiples and metrics to be conservative in our bearish view. As an indication of how bad things might get, we estimate FY 2006 EBITDA will be a loss of $3 million. Although there is not much pro form data to go on, we estimate this loss by taking 3Q05 annualized EBITDA and then assuming the Company’s energy costs rise 50% over average 2005 costs. If our outlook is anywhere close to correct, this company is substantially overvalued and due for a price correction.

Catalyst

1. Weak fourth quarter 2005 earnings driven by
a. Tightened spread between refined and raw sugar
b. Increased prices of natural gas and coal
c. Typically a weaker quarter seasonally
2. Gloomy 2006 outlook