My largest holding, Rogers Sugar Income Fund, reported a solid but not spectacular quarter. What was odd is that they released the result at 1:30pm eastern time, which was mid-day while the market was open. The market hardly blinked and then a couple hours later there was some minor volume at slightly lower prices to end the day.
The debentures (which I do not own) are trading at around 105% of par value both with a yield to maturity of less than 4%; they do not mature until June 2012 [$50M/6.0%/$5.30/unit conversion] and 2013 [$85M/5.9%/$5.10/unit conversion]. They can be called away at par in June 2010 and 2011, respectively, which is possible if they can secure cheaper financing. The debentures could even be converted to equity if the units trade above the conversion price, which is another possibility. Either way, at present, the solvency of the trust is not in question – they have very good access to credit.
I absolutely love the external reporting style of management – they do a very good job walking you through the GAAP numbers, which are contaminated with inflated and deflated numbers as a result of management’s rigorous hedging of input costs. Management then gives you metrics which separate the timing effects of the hedging. They do it in such a way that is simple, yet elegant, and this is presumably a reflection of CFO Daniel LaFrance‘s style. It is also a textbook example of why GAAP is not the be-all-and-end-all of financial reporting – this will equally be true with the implementation of IFRS (International Financial Reporting Standards), another scheme mainly to enrich accounting consultants and make financial statements even more unreadable than they are presently.
The sugar industry is something that I never quite intended on being relatively knowledgeable about, but over the past few years I’ve accumulated quite a bit of information of the industry, at least of how it applies to Canada. The industry is fairly easy to research, which makes the evaluation of management’s ability to keep costs down and be able to make educate guesses on where the marginal risks are critical, which I think Rogers Sugar has done a good job doing.
Rogers Sugar Income Fund (through Rogers Sugar in Western Canada and Lantic in Central Canada) services mostly the domestic Canadian sugar market – there is one significant competitor in Central Canada (Toronto) in Redpath Sugar and there are also fringe competitors such as Sweet Source Packaging in Toronto, which is under the label of Sweet Source Sugar. The domestic market demand for sugar has been very slowly dropping over the past decade, presumably due to industrial usage shifting toward sugar knock-offs (such as high fructose corn syrup and artificial sweeteners), but otherwise is relatively stable. Despite what one sees at Superstore and Costco, the vast majority of consumption is through industrial usage (such as most of the stuff you would see at Tim Hortons).
Because most countries heavily subsidize their sugar industries, there is a high degree of protection in the industry. As a result, Rogers Sugar, Lantic, and Redpath are able to compete primarily on domestic fronts. There is some small volume of competition that will be coming through Costa Rica through the free trade agreement implemented with them, but it should have a small impact on the domestic marketplace. In addition, the USA and Mexico occasionally open up some component of their own domestic marketplace whenever they face domestic sugar shortages – such as when an adversely located hurricane decides to wipe out their production capability.
Most of the input costs come from importing raw sugarcane from locations south of the USA and processing it into granulated sugar products. In Taber, Alberta, Rogers Sugar additionally harvests and processes sugar beets into raw sugar. The primary cost (other than labour) of refining this raw product comes from the energy consumption required to transform the product – which is through natural gas.
A positive change in price of refined sugar will have a positive impact on gross margins for Rogers Sugar, at the expense of cannibalizing some of the marketplace for substitutable sugar products as those suppliers will convert to high-fructose corn syrup. As sugar prices have been at record highs lately, it remains to be seen whether the positive impact on gross margins will be more or less offset by the reduction in sales volume.
Rogers Sugar gives off a distribution of $0.46/unit (9.75% on the current unit price of $4.72), and this quarter is the first time that management has announced that they are looking into alternative structures with respect to the onset of income trust distribution taxation in Canada. Specifically, they have stated:
We are investigating corporate structures as an alternate to our current income trust structure. Whether we convert to a corporation and as a result pay corporate income taxes or continue with our income trust structure beyond 2010 and become subject to distribution tax, we currently anticipate paying dividends or distributions at levels that would provide an after tax distribution equivalent to that currently enjoyed by our Canadian taxable Unitholders.
This statement implies that their distribution will be reduced to approximately 32 to 33 cents per unit (6.89%). This is a few pennies lower than what I was expecting (mainly 0.46/(1+26.5%) = 0.36 in 2011; 0.46/(1+25.0%) = 0.37 in 2012) but we will see. The company has been doing a good job keeping distributions lower then their free cash flow and have applied the retained earnings into a reduction in leverage – something I find to be a wise decision that will facilitate a much easier refinancing of the debentures.
