Thoughts of sweet investments often lead investors to think of chocolate maker Hershey's (HSY) long before sugar refiner, processor and distributor Imperial Sugar Company (IPSU) enters their conscious. Sugar Land, TX based Imperial Sugar Co stock, which closed at $32.07 on Tuesday, September 12, has increased roughly 140% since the beginning of the year, primarily as a result of higher gross margins from higher sugar prices.

Most customers are familiar with Imperial's Dixie Crystals brand sugar. Key variables in the domestic sugar industry such as weather conditions, processors subsidies, and government regulation intermingle to fulfill American consumption of 10 million tons, or roughly 60 lbs of sugar per person each year.

The domestic sugar industry operates on the basic economic principle of supply and demand. Prior to 2004 and 2005, domestic demand for refined sugar had been flat. Poorly performing sugarbeet crops and the effects of hurricane Katrina in August 2005 and hurricane Rita in September 2005 damaged the sugar cane crops of Imperial and its competitors in Georgia and Louisiana. Hurricane Wilma in October 2005 also hurt competitors' sugar cane crops in Florida, further curtailing the ability of U.S. farmers to meet domestic demand. As a result Imperial's volumes and prices increased due to the tight supplies.

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Quick Facts
• None of Imperial's sugar is used to produce ethanol, most ethanol in the U.S. is produced with corn
Wal-Mart (WMT) was Imperial's largest customer, accounting for 11.5% of net sales in 2005
• Imperial sold 32 million hundredweight, or cwt, of refined sugar in 2005
• Since the sale of Holly Sugar in September 2005, all of Imperial's refined sugar is derived from sugar cane

Each of Imperial's sugar customer segments, including industrial, consumer and food service experienced price increases in 2006. Imperial operates primarily using fixed price forward sales contracts. This means that Imperial is able to lock in prices for the year in advance of actual product delivery. While the 2006 prices did reflect the limited supplies of sugar brought on by the hurricanes of 2005 and import quotas, contract pricing for 2007 remains uncertain as domestic sugar crops are expected to recover. To compensate for the sugar shortfall this year the U.S. Department of Agriculture allowed for additional imports as recently as July 2006.

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U.S. policy for controlling sugar prices is outlined in the Farm Security and Rural Investment Act of 2002, also known as the Farm Bill, which runs through 2008. The main thrust of the bill is to impose a tariff-rate quota on imports and to provide a loan program to support sugar processors like Imperial. Under the current system, only 20% of U.S. demand can be filled by imports. Once the Farm Bill expires in 2008, supply and demand could be affected by NAFTA (North American Free Trade Agreement) and CAFTA (Central American Free Trade Agreement) which will increase the amounts of sugar that can be imported and exported to countries including Mexico, El Salvador and Honduras.

Imperial's earnings reveal that its trailing P/E of 25.16 is well above its forward P/E of 12.58. Hershey and Tootsie Roll's (TR) current P/E ratios are 24.51 and 20.99 while their forward P/E's are 20.99 and 22.99. Imperial's significantly lower forward P/E could be a sign of doubt by Wall Street analysts about the continued improvement of Imperial's sugar pricing as crops recover and as imports begin to gain footing.

Investors should stay current on the factors mentioned and wait for a pullback in Imperial stock price before making an investment. Worldwide trends suggest that there may by a bull market for sugar in the commodities market as developing nations acquire a sweet tooth. With the U.S. relaxing its rules on sugar imports and exports along with the potential of increased imports of sugar to support ethanol fuel initiatives, Imperial Sugar could stand to benefit in the long term should domestic supplies once again hit a sour note.

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