IPSUwill report 1Q10 results tomorrow before the market opens.  We estimate the company could report EPS in excess of $15.00 based on the company’s settlement of its property insurance claims for the Port Wentworth refinery accident.  Additionally, we estimate the company will recognize an additional $2-$4 million in gains from its raw sugar hedges, which will be accounted for on a mark-to-market basis throughout FY10.  As of 9/30/09, the company’s FY10 raw sugar hedges were marked to $29.45.  The #16 raw sugar contract on ICE closed the year slightly above $30.  Recognition of insurance settlement gains for accounting purposes should go a long way towards illuminating the inherent value in IPSU shares.

As we have discussed in the past, we think IPSU shares are remarkably compelling at current levels based exclusively on the company’s book value after giving effect to the settlement and the implicit asset value of its refineries, joint venture arrangements, and net cash position.  Pro forma for the insurance settlement, we estimate that IPSU’s book value will be close to $22.00-$22.50/share.  The book value does not reflect any contingent liability associated with outstanding civil litigation against IPSU related to the Port Wentworth refinery accident.  We continue to expect any rulings against the company in these cases to be covered by IPSU’s worker’s comp and general liability insurance policies. On a sum of the parts basis, we estimate, IPSU could be worth as much as $25-$26/share INCLUDING an incremental $50 million in contingent, non-insured  liabilities associated with the Port Wentworth refinery accident.

Source: PAA Research

From an operating perspective, we expect the company to generate revenues and a loss per share of $214.7 million and ($0.09).  Here are some of our key assumptions for the quarter:

• The company’s Port Wentworth facility operated at 50% capacity utilization over the course of the quarter
• The company produced 2,678 (cwt) for industrial clients at a price of $31.88
• IPSU produced 1,989  (cwt) for consumer clients at a price of $40.26
• Production of 892 (cwt) for foodservices clients at a price of $38.46
• Gross margins of 6% (based on the low level of capacity utilization)
• $1.0 million in other income from Wholesome Sweeteners and Santos

Key Developments During the Quarter and Questions for the Conference Call

Over the course of the quarter, here are a few key developments that could effect IPSU’s earnings prospects over the next 12-18 months (excluding ramp-up of production at the Port Wentworth facility):

• Expansion of refined sugar use in soda’s and other beverages. Pepsi and Mountain Dew throwback received a great deal of marketing support over the course of the quarter.  Dr. Pepper, Gatorade, Snapple, and Ocean Spray are other major beverage producers that have already rolled out or plan to introduce products made with refined sugar instead of high fructose corn syrup (HFCS).  Even with the recent run-up in refined sugar prices it still appears that the shift away from HFCS towards refined sugar continues to gain momentum.  The increase in demand should enable IPSU to sustain or even expand gross margins if raw sugar shortages are addressed.
• IPSU expands distribution to Walgreen’s.  During the quarter, IPSU began distributing refined sugar to more than 6,500 Walgreen’s locations nationwide.
• Sugar shortages in Mexico worsen.  In the USDA’s most recent sugar market update, the government forecast that Mexico would export approximately 760 short tons of sugar to the US for the 09/10 fiscal year.  We think this could prove to be optimistic given the likelihood that the Mexico sugar crop will fall short of expectations.  The lack of imports from  Mexico could bring the sugar stocks to use ratio below 10% in the U.S. for the first time in decades.

We have a number of questions we would like answered on the company’s earnings call.  We find it amazing how many moving parts there are in the IPSU story for such a simple business (they purchase raw sugar, refine it, and sell it).  Here’s our list of questions:

1. Are there any updates on the status of the civil litigation related to the Port Wentworth refinery accident?  We still think settlement is the most likely outcome.
2. What are the company’s expectations for raw sugar costs for the remainder of FY10 now in light of the recent spike in prices?  According to ICE, raw sugar prices have surged to $39-40, up from $30-$31 at the end of IPSU’s 4Q09.  In the company’s 10-K filing, IPSU indicated that its raw sugar costs for the year would be $27.15 based on its remaining purchase needs for FY10.  Clearly this number has moved higher, how much will depend in part on whether or not the company increased its hedges during the quarter.
3. What are the benefits to IPSU of sourcing its raw sugar needs for the Port Wentworth facility from the world market?  Almost all of the company’s raw sugar needs for its Port Wentworth facility are sourced under the TRQ program.  The spread between US and world raw sugar prices had widened out to $10+/cwt. Does the company’s reliance on raw sugar from world markets give it some cost advantage in this pricing environment.
4. Now that the Port Wentworth facility is operating at full capacity, will the company have structurally higher gross margins?  We have watched videos of some of the new operations at the Port Wentworth facility.  The efficiency gains are tremendous.  Management has not yet indicated how this new facility will impact the company’s profitability on a structural basis.
5. How will the company handle both its sugar and natural gas hedges going forward?The #16 sugar contract is in backwardation, prices for FY11 contracts are closer to $29-$30, opposed to $39-$40 for the front month. How will IPSU handle its hedging programs for sugar in light of the recent run-up in raw sugar prices.  For natural gas, prices remain relatively depressed (in a historical context) will the company be more aggressive in extending its hedges in the current environment?
6. How does the  company plan to use its free cash flow going forward now that the large part of CAPEX related to the Port Wentworth rebuild has been completed?  IPSU should generate $30-$40 million of free cash flow over the next 12-months.  Historically, the company has issued special dividends. We think it is more likely that the  company will use free cash flow to pursue strategic acquisitions this time around.  IPSU will likely buy in the remaining 50% ownership stake in Wholesome Sweeteners in the fourth quarter of 2010.  IPSU is evolving towards a less capital intensive business and one that is likely to include more strategic joint ventures and product expansions.
7. What percentage of IPSU’s industrial contracts are booked for FY10 and how many contracts have been booked for FY11?  Price realization for IPSU’s industrial customers typically lags the move in spot sugar prices. This can leave the company exposed to sharp increases in input costs if IPSU has not acquired and/or hedged its raw sugar needs for those customers.  Conversely, a decline in raw sugar costs following a significant run-up can be advantageous to IPSU if the company has booked a high percentage of industrial contracts (look at FY07 performance for example). It appears that IPSU had enough inventory and sugar hedges in place to fulfill the needs for its industrial customers for FY10.  We know that industrial customers have been reluctant to lock in contracts over the past 3-6 months, although that has backfired given the continued increase in prices.  We would like to know more about the company’s contract book for FY10 and FY11. 

WE anticipate IPSU’s 1Q10 results should bring investors one-step closer to focusing on the company’s fundamental earnings power and asset value.  It is important to note that settlement of the property and business interruption claims has NO bearing on the outcome of civil litigation against IPSU.  As we have determined above, the base level equity or asset value of IPSU now is $22-$26/share.  This does not include the benefits of what are likely to be strong earnings for the company over the next 12-24 months. We estimate IPSU could increase its book value by as much as 25-30% over the next two years to $27-$29, which implies shares remain grossly undervalued.

As always, please act accordingly…