IPSU issued its 1Q10 10-Q filing this morning.  For the first time, IPSU provided P&L disclosure on Wholesome Sweeteners and Santos separately.  In the past, we have argued that the company’s ownership stakes in Wholesome Sweeteners and Santos could be worth as much as $50 million. Based on the additional disclosures we evaluated today, it appears that our estimation of the value of IPSU’s Wholesome Sweeteners ownership stake could be too low.  More importantly, we think investors should increasingly consider IPSU’s potential purchase of the remaining ownership stake in Wholesome Sweeteners as a positive catalyst for shares.

Valuing Wholesome Sweeteners – Purchasing the Remaining Ownership Stake Will be Highly Accretive

In its 10-Q filing, IPSU provided limited financial disclosures on revenue, gross profit, and net income for Wholesome Sweeteners. Overall, Wholesome Sweeteners generated 31.3% YOY revenue growth to $24.7 million in 1Q10 and net income of $2.0 million, which implies an 8.1% margin.  Wholesome Sweeteners has benefited from better distribution  for some of its products such as blue agave syrup at national retailers like Costco.  Currently, IPSU has a 50% ownership stake in Wholesome Sweeteners, so the company’s result are not consolidated.  IPSU has an option to purchase the 50% stake it does not own between September 2010 and May 2011 at a pre-determined multiple of Wholesome Sweeteners earnings.  We fully expect IPSU to pursue this option given Wholesome Sweeteners’ high margins, rapid growth, and lower earnings dependence on volatile sugar prices.  The transaction would be highly accretive based on our estimates and should result in a more stable normalized earnings profile for IPSU.

Acquisition of Remaining Ownership Stake in Wholesome Sweeteners Could be $0.25-$0.35 Accretive to Annual EPS

We have analyzed the accretion/dilution potential of IPSU’s potential purchase of the remaining ownership stake in Wholesome Sweeteners based on the company’s more detailed disclosure.  Here are a few key assumptions we have made:

• No seasonality in Wholesome Sweeteners’ revenues or earnings. As a result we have annualized Wholesome Sweeteners’ 1Q10 results to get to annual revenue and net income projections.  In its FY09 10-K filing IPSU indicated that Wholesome Sweeteners generated $70 million in revenues for the FY09 fiscal year. Assuming the company can continue to generate 30% revenue growth, it does not seem unreasonable to assume that Wholesome Sweeteners can produce $95-$100 million in sales annually in 2010.
• A purchase price of $35 million for the remaining 50% ownership stake.  This could prove to be a bit low. We don’t know what the pre-determined multiple is that will dictate the purchase price IPSU will pay.  IPSU will purchase Edward Billington and Son’s ownership stake.  If our forecast for Wholesome Sweeteners’ 2010 net income is correct, a purchase price of $35 million would imply an 8.5-9.0x multiple of the company’s net income.  That appears low, but it is important to note that the agreement with Edward Billington and Sons was forged before the commercial success of Wholesome Sweeteners product line was proven.
• $0.5 million of lost interest income on the $35 million purchase price. We anticipate that IPSU would fund the purchase from cash from operations over the next several quarters.  Based on current interest rates, we estimate IPSU would forego $0.5 million in annual interest income in order to purchase the 50% ownership stake in Wholesome Sweeteners.

Overall, in our base case scenario, our accretion/(dilution) analysis suggests that a purchase of the remaining 50% ownership stake in Wholesome Sweeteners would be $0.29 accretive to IPSU’s annual EPS.  As we mentioned earlier the more important impact would be on IPSU’s normalized EPS and growth profile.  A fully consolidated, 100% owned Wholesome Sweeteners would contribute $0.66 in annual EPS to IPSU.  We would argue that the earnings stream from Wholesome Sweeteners should be afforded a higher multiple given the company’s growth rate, margins, and reduced economic reliance on volatile sugar prices.  At a 15x multiple on Wholesome Sweeteners fully consolidated, 100% owned earnings stream, we estimate the division could be worth $9.50-$10.00 per share for IPSU.  In the table below we outline some of our key assumptions in our accretion/(dilution) analysis and valuation of Wholesome Sweeteners.

Source: PAA Research

Given the limited disclosure we have received on Wholesome Sweeteners historically and the uncertainty surrounding the purchase price multiple for the remaining ownership stake we have conducted an accretion/(dilution) scenario analysis based on two variables: net Income margin for Wholesome Sweeteners and the purchase price. As the table below demonstrates, the transaction is accretive to IPSU’s earnings in almost any scenario.

Source: PAA Research

Additionally, our estimate of a fully consolidated, 100% owned Wholesome Sweeteners of $9.50-$10.00 share is highly contingent upon the net income margin and multiple afforded to the division.  In the table below we have conducted a scenario analysis of the value to IPSU shareholders of a 100% owned Wholesome Sweeteners along two scenarios: the division’s net income margin and the earnings multiple.  Overall, we think Wholesome Sweeteners could be worth as little as $1.65/share or as much as $16.50/share to IPSU shareholders if it is fully consolidated and 100% owned.

Other Tid-bits from the 10-Q

Here are a few other key tidbits from the company’s 10-Q filing:

• IPSU had $137.8 million in inventory as of 12/31/09, the company’s highest level since FY06.  Normally a large inventory build would be a source of concern, but in this case it is actually a big advantage.  IPSU likely built inventories over the course of the quarter in advance of the ramp-up of capacity at Port Wentworth.  The larger inventory build should help IPSU keep raw sugar input costs lower than they would otherwise be given the sharp run-up in domestic sugar prices.
• IPSU had sugar hedges in place on 4.3 million cwt of raw sugar for FY10 at a price of $27.09.  These contracts were marked to fair market at price of $33.38 as of 12/31/09, which resulted in IPSU’s gain of $18.9 million in 1Q10 for IPSU.  The gains have the effect increasing IPSU’s raw sugar costs in future quarters from an accounting perspective. IPSU recognized an additional $22.5 million in derivative gains in January based on the huge  run-up in the #16 futures contract.  Assuming that domestic raw sugar prices stay at current levels those gains will be reported in the current quarter.
• If the balance of the company’s raw sugar purchases for FY10 were priced in the domestic futures market on 2/5/10, IPSU’s raw sugar costs for FY10 would be $30.35.  This represents an increase from $27.15, which the company disclosed its raw sugar costs would be in its 10-K based on futures prices as of 12/4/09.  On the surface it might appear that IPSU could be at risk of getting squeezed by higher raw sugar costs.  However, the company has hedges in place for approximately 25% of its production for the rest of FY10 and raw sugar inventory for another 20-30%.  Additionally, based on our checks with sugar brokers, IPSU has been passing along price increases despite what management indicated on its earnings conference call.  Current spot pricing for refined sugar is in a range of $52-$55/cwt.  We think it is highly likely that IPSU’s realized price on industrial contracts will increase to a range of $35-$38/cwt over the next 2-3 quarters, while those for consumer and food service companies could increase to $45-$48/cwt.  Under this scenario, IPSU would generate a refined/raw spread of $10-$12/cwt, possibly more for FY10.

IPSU’s increased disclosure on the financial profile of Wholesome Sweeteners adds further credence to our thesis that IPSU’s asset value is considerably higher than the current share price.  There has been a global surge in interest in sugar assets over the past 3-6 months due to the prospects for rising demand and tight supplies for the foreseeable future. IPSU is well positioned to benefit from the increased use of refined sugar in beverages and other products over the coming years. We find it highly unlikely that the stock will trade at 0.6x tangible book value and 55% of real asset value when the company’s earnings prospects are rapidly improving and global interest in sugar assets is surging.

As always, please act accordingly…