The Rocky Mountain Sugar Growers' Cooperative: “Sweet” or “Sugar-Coated” Visions of the Future?†
Teaching notes are available from the author upon request.
Abstract
In late 2001, sugarbeet producers in Montana, Wyoming, Colorado, and Nebraska were contemplating the formation of a new generation cooperative to purchase sugarbeet processing facilities from Tate and Lyle North American Sugars, Inc. The U.S. sugar industry critically depends upon U.S. sugar policy. In recent years, sugar and sugarbeet prices have been relatively low. This case examines the competitive, strategic, investment, and risk issues associated with this cooperative venture. The case places students into a decision environment that existed in the latter part of 2001. Thus, the Farm Security and Rural Investment Act of 2002 (FSRI) had not been finalized. In addition, a variety of ownership and consolidation issues contributed to much uncertainty regarding the future of sugarbeet processing. Students are asked to calculate a weighted average cost of capital and prepare projected cash flows using financial information in the case.
On a crisp, bright, late-September morning in 2001, Rick Dorn is harvesting sugarbeets near Hardin, Montana. Rick frowns as he punches the “End” button on his cell phone and tosses it to the side. His concern does not involve the skill needed to operate his John Deere tractor, nor the complicated feat of keeping his trailing, six-row sugarbeet harvester “in-the-row” while simultaneously coordinating “on-the-go” loading of the tandem-axle truck currently moving beside the harvester. After many years of performing this delicate balancing act, he enjoys the harvesting operations unique to sugarbeet production. Even his neck and shoulders are used to the demands of alternately looking backward, sideways, and forward to properly operate the harvester. Furthermore, he has been pleased that the early harvest portion of this season has gone smoothly. Yields have been reasonable, and the current dry, cool conditions have made for an enjoyable start to this critical three-week harvest season.
His concern involves the just-completed cell phone call that has brought distressing news from a term-debt lender. In the aftermath of the September 11 terrorist attacks that increased the riskiness of many venture-capital investment portfolios, the lender has informed him that they will not be able to meet their verbal commitment to supply financing to the fledgling Rocky Mountain Sugar Growers Cooperative. The financing is critical for sugarbeet producers in the Rocky Mountain States to form a cooperative and purchase the processing assets of the Western Sugar Company offered for sale by Tate & Lyle North American Sugars, Inc. After more than a year of work, negotiations, number crunching, frustration, and soul searching, the imminent purchase has been dismantled by a five-minute phone call.
As he motions to the driver indicating the truck is full, he muses about the way sugarbeets are harvested. Sugarbeet harvesters are pulled by tractors that also supply hydraulic, electrical, and mechanical power. Adjustments to each of these factors are frequently required as the harvester moves through a field. The harvester operator must also orchestrate the position of trucks as they are loaded “on the go.” In addition, the harvester operator spends more time looking backwards at the six-row digger (so that horizontal and vertical hydraulic adjustments can be made to avoid slicing beets and, thus, leaving them in the field) than looking forward. He wonders if sugarbeet producers in the Rocky Mountain region, and perhaps potential term-debt lenders, are similarly spending too much time looking backward—and, given his recent cell phone call, if it is worth spending any additional time looking ahead.
This case examines the competitive, strategic, investment, and risk issues associated with this cooperative venture. The case places students into a decision environment that existed in the latter part of 2001. Thus, the Farm Security and Rural Investment Act of 2002 (FSRI) had not been finalized. In addition, a variety of ownership and consolidation issues contributed to much uncertainty regarding the future of sugarbeet processing.
The U.S. Sugar Industry
Sugar, or sucrose, is a carbohydrate that occurs naturally in every fruit and vegetable. It is the major product of photosynthesis, the process by which plants transform solar energy into food. Sugarbeets and sugarcane are two plants that photosynthesize significant quantities of sugar. Although refined sugar from each of these plants is indistinguishable, there are important differences in the production of sugar from these two sources.
Sugarbeet Production
Sugarbeets are similar to red beets in shape, but have a larger white root and are inedible. Approximately 35% of world sugar production is produced from sugarbeets. United States sugarbeet production occurs primarily in the Upper Midwest (Minnesota and North Dakota), northern Great Plains (Colorado, Montana, Nebraska, and Wyoming), Great Lakes (Michigan and Ohio), and the Far West (California, Idaho, Oregon, and Washington) (table 1). More than 25 million tons of sugarbeets are produced annually. The production cycle for sugarbeets generally begins with land preparation during late summer or early fall of the previous year. Moldboard plowing or heavy disking of land planted to a nonsugarbeet crop (usually malting barley, wheat, or corn) for the previous two years usually occurs at this time. Roller harrowing, land leveling, and fertilizing are typical fall tillage practices. Many irrigated producers also ridge the soil in the fall in preparation for spring planting. Sugarbeets are generally planted in early April. The selection of seed variety and fertilizer application rates is critical for determining yields and beet quality.
| Year | Great Lakesa | Upper Midwestb | Great Plainsc | Far Westd | Total Sugarbeet | Total Sugarcane |
|---|---|---|---|---|---|---|
| 1985 | 131 | 420 | 185 | 367 | 1103 | 830 |
| 1986 | 125 | 475 | 231 | 361 | 1192 | 835 |
| 1987 | 158 | 471 | 231 | 392 | 1252 | 840 |
| 1988 | 160 | 510 | 239 | 392 | 1301 | 855 |
| 1989 | 162 | 521 | 249 | 361 | 1293 | 870 |
| 1990 | 176 | 557 | 271 | 371 | 1375 | 850 |
| 1991 | 185 | 557 | 272 | 372 | 1386 | 873 |
| 1992 | 196 | 565 | 282 | 367 | 1410 | 893 |
| 1993 | 205 | 570 | 277 | 355 | 1407 | 914 |
| 1994 | 203 | 613 | 257 | 358 | 1431 | 904 |
| 1995 | 203 | 624 | 250 | 329 | 1406 | 882 |
| 1996 | 135 | 663 | 230 | 295 | 1323 | 875 |
| 1997 | 161 | 674 | 263 | 331 | 1429 | 830 |
| 1998 | 174 | 701 | 220 | 357 | 1452 | 860 |
| 1999 | 192 | 717 | 254 | 365 | 1528 | 888 |
| 2000 | 167 | 662 | 220 | 330 | 1379 | 941 |
| 2001 | 174 | 711 | 188 | 258 | 1331 | 970 |
- a Michigan and Ohio.
- b Minnesota and North Dakota.
- c Montana, Nebraska, and Wyoming.
- d California, Idaho, Oregon, and Washington. Source: U.S. Department of Agriculture.
Throughout the spring, several mechanical cultivation passes and as many as six chemical applications are used to control weeds. Some producers hire workers to pull weeds from fields. Additional fertilizer and chemical applications are used to provide nutrients and control insects and disease. Most sugarbeet acreage in the West is flood irrigated using open ditches and siphon tubes or gated pipe. Some production occurs under center-pivot sprinklers. Each field is irrigated five to eight times. Irrigation is not used in the Upper Midwest region. Harvest begins either in late September or early October.
After harvest is completed, the land is generally disked or plowed in preparation for planting a nonsugarbeet crop the following spring. Because sugarbeet production is a labor-, machinery-, and input-intensive process, variable production costs may exceed $500/acre. Landlords who rent land to sugarbeet producers on a crop-share basis generally receive between 20 and 25% of gross crop value from tenants.
Sugarcane Production
Sugarcane is a tropical grass native to Asia that grows in warm climates. Sugar is obtained from the stalks of the plants. Because of climatic conditions, U.S. production occurs in Florida, Louisiana, Texas, and Hawaii. Sugarcane planting occurs from late August through January.
Sugarcane is harvested from October through March. Unless frost occurs, sugar yields are highest after January 1. However, some fields must be harvested before reaching maximum sugar yields to accommodate cane-milling schedules. Harvesting sugarcane requires that fields be burned to remove dead leaves that would otherwise impede harvest, interfere with milling machinery, and absorb sugar during the extraction process. In the past, most sugarcane was cut by hand using cane knives. Improvements in mechanical harvesters have resulted in a complete movement away from hand harvesting.
Machine-cut cane stalks are deposited directly into wagons by a harvester. Four-wheel drive tractors haul 16 tons of cane from fields with each four-wagon load. Using special ramps near cane fields, sugarcane is dumped from the wagons into truck trailers or rail cars for transport to mills. Rail cars carry 25–30 tons each and truck trailers carry 20 tons per load.
After a field has been harvested, weeds need to be controlled. A second crop of stalks, called ratoons, grow from the old plant stubble. The second crop is harvested about one year after the first harvest. Usually, about three annual crops are taken from one field before replanting. When production declines to an unacceptable level due to insect, disease, or mechanical damage, the old-growth cane plants are plowed under after harvest, and the land is prepared for replanting.
Sugar Processing
Sugar extraction rates and sucrose contents of both cane and beets are critical determinants of processor profitability. Sugarcane and sugarbeets have similar raw material yields per acre, but sugarcane has a slightly lower extraction rate. Technology has helped increase extraction rates in recent years.
Once harvested, the sugar content of sugarcane stalks and sugarbeet roots deteriorate. Thus, it is important to process the raw material as quickly as possible. Sugarbeets are harvested in the fall prior to the soil freezing and are stored in open piles. As long as temperatures remain below freezing and beets have been piled with relatively small amounts of residual mud, dirt, and vegetation, the sugar content of piled beets declines relatively slowly. However, unusually warm winters or early springs cause significant “pile losses.” Thus, a typical processing plant operates between 180 and 240 days per year.
Sugarcane processing plants also operate seasonally. However, sugarcane is harvested “as needed” by processing plants because the temperate climates of sugarcane producing regions makes it unnecessary to inventory cane stalks. Rather, harvests are coordinated so harvested sugarcane is quickly processed and cane factories can continually operate during the harvest season.
During the refining process, sugar stored in cane stalks or beet roots is separated from the rest of the plant material. For sugarcane, this is accomplished by grinding cane stalks to extract juices, boiling extracted juice until a syrup is created and crystallized, and spinning the crystals in a centrifuge to produce brown raw sugar crystals. Raw sugar is shipped to separate refineries to be washed and filtered to produce white sugar. The “clean” material is then crystallized, dried, and packaged as granulated white sugar.
Sugarbeet processing occurs within a single plant. Sugarbeets are washed, sliced, and soaked in hot water to remove sugar-containing juices. The juice is purified, filtered, concentrated, and dried in a series of steps similar to sugarcane processing. By-products created by this process include molasses (for human consumption) and beet pulp (for livestock feed). Sugar produced from sugarbeets and sugarcane is called refined sugar.
Industry Structure
The largest sugarcane refining companies include Imperial Holly (38% market share), Tate & Lyle (36%), C&H (16%), and Refined Sugars (8%). The top four sugarbeet processing firms are Snake River Growers (24% market share), Tate & Lyle (23%), American Crystal Sugar Company (21%), and Imperial Holly (16%).
Pricing
Pricing is extremely competitive in the sugar industry. Production costs differ among regions, and sugarcane has production cost advantages over sugarbeets. U.S. domestic sugar prices have been supported above world prices through the use of import quotas and other trade policy measures. Nonetheless, sugar is difficult to differentiate. Hence, the ability to market sugar to domestic users at prices below other competitors is a huge competitive advantage.
Customers
There are two primary markets for refined sugar: industrial and nonindustrial users. Industrial market segments include bakery and cereal, confectionery (candy), other food uses, dairy (primarily ice cream), beverage, and other nonfood uses. This market has grown slowly over time. Nonindustrial market segments include wholesalers, retailers, hotels, restaurants, and institutions. Similar to the industrial market, this market has grown slowly. Sugar quality is an important factor for customers in both market segments.
Suppliers
Many, but not all, sugarbeet processing firms are vertically integrated. Both producer-owned cooperatives and private firms own sugarbeet processing facilities. Private firms control most sugarcane production and processing assets. The percentage of sugar in sugarcane or sugarbeets is important for profitability, but varies from year to year depending upon weather, fertilizer applications, and choice of seed varieties.
Principal Market Segments
Grocery sales
Sugar is sold in granulated white, brown, and powdered forms through grocery stores in packages ranging from 1-pound boxes to 25-pound bags. Private-label packaged sugar is generally sold at prices lower than branded sugar.
Foodservice sales (including sales of nonsugar products)
Numerous products are sold to foodservice customers and healthcare institutions. These range from 50-pound bags to individual packets of sugar, salt, pepper, nondairy creamer and plastic cutlery, nutritional dry mixes, sauces, seasonings, drink mixes, desserts, and diet kits (packets of plastic cutlery with seasonings, and other items). Foodservice is one of the most rapidly growing segments of the domestic food industry.
Industrial sales
Refined sugar, molasses, and other ingredients are sold to industrial customers such as food manufacturers in bulk, packaged, or liquid form. Food manufacturers primarily purchase sugar for use in confections, baked products, frozen desserts, canned goods, and various other food products. Industrial sales generally provide lower margins than grocery or foodservice sales.
Specialty product sales
Specialty sugar is sold to grocery, foodservice, and industrial customers. Products include premium-priced, free-flowing brown sugar marketed primarily to industrial customers, liquid flavorings, edible molasses, syrups, sugar produced from organically grown sugarcane, and specialty sugars used in confections, fondants, and icings.
Industry Trends
Several major trends have emerged in the sugar industry, including: (a) increased demand for products obtained from corn sweeteners; (b) trade liberalization agreements with Mexico and Canada; (c) corn and sugarbeet acreage increases due to the 1996 Federal Agricultural Improvement and Reform Act; (d) consolidation of beet and cane sugar companies with corn sweetener firms; and (e) the U.S. Customs Service interpretation of rules governing “stuffed molasses” imports from Canada.
Consumption
The U.S. Department of Agriculture estimates that the most popular high fructose corn syrup segment (HFCS-55), grew approximately 4–4.5% annually between 1975 and 2002. Soft drink beverage companies drove much of this growth. Thus, corn sweetener production has steadily increased over time. By 1985, U.S. soft drink manufacturers had completely switched from sugar to HFCS.
HFCS trade with Mexico
The Mexican market offers opportunities for dramatic volume growth because of trade liberalization and the potential to substitute HFCS for sugar in beverages. Mexico is a large producer of sugarcane, but has only a small HFCS industry. Under the North American Free Trade Agreement (NAFTA), Mexico's import tariff on United States HFCS fell to 9% in 1997, and was scheduled to decrease by 1.5% each year thereafter until 2003, when the tariff would be eliminated. This represents a potentially huge growth opportunity for HFCS producers—especially if real consumer incomes increase in Mexico. Exports of HFCS from the United States increased after NAFTA. It was expected that HFCS would displace some sugar consumption in Mexico.
U.S. farm policy
Corn and sugarbeet production increased in the 1990s as legislation provided farmers with greater planting flexibility. Corn production replaced wheat in some parts of the Upper Midwest. With the elimination of marketing allotments, sugarbeet production increased as producers substituted away from lesser-valued crops. Sugarcane acreage also expanded for similar reasons and yields increased due to varietal improvements.
Consolidation
Since the 1980s, consolidation has occurred among sugarcane and sugarbeet processing companies. The rationale was that production and price risk caused by regional weather patterns could be better managed if a company owned both sugarbeet and sugarcane processing assets. For example, Imperial Sugar, a Texas sugarcane company, acquired the Holly Sugar Corporation, a sugarbeet processor with factories in California, Texas, Wyoming, and Montana. It then acquired Savannah Foods and Spreckels in 1998. British-based Tate & Lyle owned sugarbeet factories in the European Union (EU) and other parts of the world. It also owned A.E. Staley, which was one of the largest HFCS companies in the United States. Tate & Lyle acquired Domino Sugar Company, a sugarcane processor that refines U.S. sugarcane and imported raw sugar, and Western Sugar, a sugarbeet company with factories in Nebraska, Wyoming, Montana, and Colorado.
Stuffed molasses
Over the past several years, a loophole in U.S. Customs rules enabled U.S. firms to import molasses syrup from Canada that had been “stuffed” with Brazilian sugar. The imported syrup was approximately 95% sugar and 5% molasses. U.S. firms extracted sugar from the molasses and shipped the syrup back to Canada to be “restuffed” with additional sugar. This process accounted for about 125,000 metric tons of sugar imports annually. The loophole occurred because molasses was not classified as sugar by U.S. Customs. Although the intent of U.S. sugar policy regarding imports was being violated, the practice has only recently been stopped.
Molasses desugarization
Because sugarbeet molasses is a low-value by-product, the extraction of additional sugar from molasses provides an opportunity to improve competitiveness. Remaining molasses and by-products obtained from molasses desugarization are marketed primarily to yeast manufacturers and feedlot operators.
A Historical Perspective on U.S. Sugar Policies
United States sugar policies began in 1789 when a tariff was levied on imported sugar. The purpose of the tariff was to raise money for the U.S. Treasury rather than to protect the domestic industry since no sugar was produced in the United States at the time (Schmitz, Allen, and Leu). The U.S. sugar industry developed during the nineteenth century. An import tariff was eventually used to protect domestic producers and, except for several short periods, remained in effect until 1934. Sugar policy has continued through a series of acts with suspension occurring only twice since 1934.
The Food, Agriculture, Conservation, and Trade Act of 1990 modified sugar policy through the introduction of nonrecourse loans to processors, tariff-rate quotas (TRQ), and domestic processor marketing allotments. Nonrecourse loans guaranteed a minimum support price for producers. If the domestic price of sugar fell below the loan rate, processors could forfeit the loan collateral (i.e. refined sugar) to the Commodity Credit Corporation (CCC). However, to maintain a no-cost policy stipulation, the domestic price of sugar was kept above the loan rate through a TRQ mechanism. The TRQ allowed only limited sugar imports at low tariff rates. All imports above the TRQ were assessed a relatively high second-tier tariff. If the import quota was met and the price of sugar was still below the loan rate, domestic marketing allotments could be imposed to support prices.
Between 1996 and 2001, U.S. sugar policy was a product of the 1996 Federal Agriculture Improvement and Reform Act (FAIR). The FAIR Act allowed sugar processors to obtain either nonrecourse or recourse CCC loans. The decision regarding whether loans should be nonrecourse or recourse is an important consideration for the support of domestic sugar prices. The FAIR Act suspended processor marketing allotments. The GATT/Uruguay Round agreement obligated the United States to maintain duty-free access for at least 1.256 million tons of sugar annually.
The FSRI proposed several important changes to the 1996 FAIR Act, including reinstating processor marketing allotments. Under the proposed change, Western Sugar is allowed to market 9.2% of domestic sugar production. In addition, FSRI was expected to maintain the CCC loan rate at 22.90 cents/lb for beet sugar through 2007 and eliminate marketing assessments on producers. United States import obligations under the WTO agreement were 1.536 million short tons, which include 0.276 million short tons from Mexico plus 1.256 million short tons from the rest of the world. If total imports exceed 1.532 million short tons, sugar marketing loans become nonrecourse loans that can be forfeited to the CCC. Thus, the Secretary of Agriculture has strong incentives to resolve issues related to sugar imports from Mexico.
United States sugar policy has been the subject of several studies that have considered the impact of government policy on social welfare (e.g., Borrell and Duncan; Leu, Schmitz, and Knutson; Lopez; Schmitz, Allen, and Leu). Leu, Schmitz, and Knutson discussed the benefits and costs of the sugar policy on consumers, producers, taxpayers, and exporting countries. They also evaluated the effects of alternative policies such as tariffs and target-price deficiency payments. Analysis of the benefits and costs under a TRQ system show that U.S. sugar policy costs taxpayers very little to administer, while sugar producers capture rents from domestic prices that exceed world sugar prices. Consumers pay a higher price for sugar because they are excluded from the low prices of the world market. A recent report by the United States General Accounting Office estimated that sugar policy cost U.S. sweetener users about $1.9 billion in 1998 (United States General Accounting Office).
The Western Sugar Company
The Western Sugar Company was formed in 1985 and is a wholly owned subsidiary of Tate & Lyle. The Western Sugar Company is one of the largest U.S. sugar refining and processing companies. Western's annual sugar production is approximately 1 billion pounds, all from sugarbeets. Sugar and sugar processing by-products are produced in Western's six factories in Montana (Billings), Wyoming (Lovell), Colorado (Greeley and Fort Morgan), and Nebraska (Scottsbluff and Bayard). The Scottsbluff plant includes a desugarization unit.
The plants were constructed between 1906 and 1917. In general, each contains pulp dryers and uses both coal and gas boilers. In addition, each has both silo and flat storage capacities and is located on functioning rail lines. Daily sugarbeet slicing capacity varies among the factories (Bayard, 2,900 tons; Lovell, 3,050 tons; Greeley, 4,000 tons; Billings, 4,600 tons; Scottsbluff, 4,700 tons; Fort Morgan, 5,800 tons). The company owns storage facilities in Colorado at Longmont, Sterling, and Rocky Ford, and in Nebraska at Mitchell and Gering. These facilities provide Western with 1.9 million hundredweight of silo storage in addition to that which exists at each factory.
Western's total slicing capacity is over 25,000 tons of sugarbeets per day with a total annual slicing capacity of more than 3.4 million tons. Western employs approximately 600 workers year-round and another 1,100 during the processing campaign. During the 2000–2001 season, Western contracted for approximately 186,000 acres of sugarbeets.
Western sells sugar primarily in the Rocky Mountain and Midwest regions. Approximately 26% of Western's sugar production is sold to wholesalers, distributors, or retailers. The remainder is sold to industrial users (i.e, major food manufacturers). Refined sugar is sold in several forms: (a) consumer products such as powdered, brown, and granulated sugar; (b) food service products (primarily single-serve packets); (c) industrial packages (e.g., 50 and 100 pound bags of granulated, baker's special, and powdered sugar); and (d) bulk sugar (railcar, bulk truck, and tote bags). Western also produces by-products of sugar processing, including beet pulp, beet pulp pellets, beet molasses, and molasses desugarization solubles—all of which are used for livestock feed. These feed inputs are generally sold to local livestock and dairy operators in areas surrounding each factory.
Sugarbeet producers receive payment for sugarbeets based on both quantity and quality of beets produced. Samples are taken from every other truckload delivered by each grower on each parcel of contracted land as beets are piled at receiving stations. These samples are used to determine the quantity being piled and average sugar content of “clean” weight beets. Growers generally receive four payments for sugarbeets throughout the year. In general, the first installment of approximately 70% of the expected total payment is received in November. Normally, another three installments are received throughout the subsequent 10-month period. The total amount received for each sugarbeet crop is not known until just before the harvesting of the next crop. Total payments are determined by total sugar revenues received by Western Sugar net of marketing costs. Growers also share in “pile losses,” and each grower's total payment per ton is adjusted for quality. In general, a 1-percentage point increase in sugar content is worth approximately $3.00/ton. Tables 2 and 3 present unaudited financial statements. Table 4 provides detailed production information for the Western Sugar Company.
| Item | 1996 | 1997 | 1998 | 1999 | 2000 |
|---|---|---|---|---|---|
| ASSETS | |||||
| Current assets | |||||
| Cash | n.a. | n.a. | n.a. | n.a. | n.a. |
| Accounts receivable | 21,861 | 66,499 | 34,107 | 37,413 | 29,002 |
| Inventories | 57,842 | 29,358 | 37,503 | 59,936 | 26,094 |
| Prepaid expenses | 12,096 | 25,166 | 25,049 | 24,130 | 26,290 |
| Total Current Assets | 91,799 | 121,023 | 96,659 | 121,479 | 81,386 |
| Long-term assets | |||||
| Property & equipment | 139,895 | 165,281 | 167,981 | 162,133 | 147,731 |
| Total assets | 231,694 | 286,304 | 264,640 | 283,612 | 229,117 |
| LIABILITIES | |||||
| Current liabilities | |||||
| Notes payable | 53,891 | 75,261 | 73,067 | 85,665 | 57,786 |
| Accounts payable | 60,104 | 40,322 | 36,558 | 38,934 | 26,652 |
| Income taxes payable | 13 | 10,583 | (3,948) | 500 | n.a. |
| Total current liabilities | 114,008 | 126,166 | 105,677 | 125,099 | 84,438 |
| Noncurrent liabilities | |||||
| Deferred income taxes | 18,996 | 27,762 | 30,900 | 27,785 | 28,716 |
| Other | 0 | 3,597 | 4,008 | 4,183 | 0 |
| Total noncurrent liabilities | 18,996 | 31,359 | 34,908 | 31,968 | 28,716 |
| TOTAL EQUITY | 98,960 | 128,779 | 124,056 | 126,544 | 115,963 |
| Item | 1996 | 1997 | 1998 | 1999 | 2000 |
|---|---|---|---|---|---|
| Sales Revenue | |||||
| Sugar and by-products | 232,706 | 268,532 | 223,431 | 209,705 | 261,933 |
| Sugarbeet costs (est.) | 112,500 | 143,000 | 140,000 | 121,000 | 150,000 |
| Other production costs | 95,788 | 73,561 | 60,760 | 71,393 | 100,694 |
| Cost of goods sold | 208,288 | 216,561 | 200,760 | 192,393 | 250,694 |
| Gross profit | 24,418 | 51,971 | 22,671 | 17,312 | 11,239 |
| Administrative/general exp | 8,648 | 6,218 | 7,171 | 6,461 | 5,702 |
| Pretax income before interest | 15,770 | 45,753 | 15,500 | 10,851 | 5,537 |
| Interest expense | 4,389 | 5,993 | 6,859 | 6,985 | 9,169 |
| Pretax income—operations | 11,381 | 39,760 | 8,641 | 3,866 | (3,632) |
| Income tax expense | 3,870 | 13,518 | 2,938 | 1,314 | (1,235) |
| Net income | 7,511 | 26,242 | 5,703 | 2,552 | (2,397) |
| Item | 1996 | 1997 | 1998 | 1999 | 2000 |
|---|---|---|---|---|---|
| Calendar year planted and harvested | 1995 | 1996 | 1997 | 1998 | 1999 |
| Acres harvested | 152.8 | 149.3 | 171.1 | 153.4 | 174.0 |
| Sugarbeets | |||||
| Tons purchased per acre | 18.5 | 20.0 | 20.2 | 21.3 | 21.4 |
| Total tons purchased | 2,821 | 2,980 | 3,455 | 3,275 | 3,716 |
| Total tons sliced | 2,666 | 2,816 | 3,265 | 3,095 | 3,512 |
| Shrinkage | 5.49% | 5.49% | 5.49% | 5.49% | 5.49% |
| Sugar percentages | |||||
| Sugar content of beets | 16.00% | 16.90% | 15.70% | 15.20% | 15.80% |
| Sugar extraction rate | 80.10% | 81.50% | 77.90% | 78.80% | 79.90% |
| Pounds of sugar extracted per ton of sugarbeets | 256 | 275 | 245 | 240 | 252 |
| Hundredweights of sugar extracted per acre | 50.1 | 50.6 | 44.8 | 47.5 | 51.0 |
| Production for crop year | |||||
| Sugar hundredweights | 7,663 | 7,794 | 7,667 | 7,233 | 8,875 |
| Beet pulp tons (est.) | 140 | 142 | 140 | 132 | 162 |
| Molasses tons (est.) | 53 | 54 | 53 | 50 | 61 |
| Net beet payment to growers | |||||
| Total (million dollars, est.) | 112,500 | 143,000 | 140,000 | 121,000 | 150,000 |
| Average per acre (dollars) | 738 | 962 | 818 | 786 | 865 |
| Average per ton (dollars) | 39.90 | 48.10 | 40.50 | 36.90 | 40.40 |
The Rocky Mountain Sugar Growers Cooperative
The Rocky Mountain Sugar Growers Cooperative was formed in June 2000 to acquire the Western Sugar Company. Cooperatives are organizations whose members/owners must be users of the business or services. Cooperatives may be able to avoid corporate income tax liabilities if profits are appropriately distributed to members. In recent years, “new generation” cooperatives have been established that are closed to membership by others. Essentially, new members must purchase stock from existing members if they want to participate. New generation cooperatives have formed to reward investors who incur the greatest risk (generally, initial investors). This is an important factor for generating equity capital.
The owners of new generation cooperatives are voting members who control the cooperative, provide equity capital, and (as patrons) receive the benefits of the cooperative, including a market or buyer for their products and a share of the profits based on use or patronage. In the case of the Rocky Mountain Sugar Growers Cooperative, profits or net income would likely be distributed in the form of patronage refunds per ton of delivered sugarbeets.
The Rocky Mountain Sugar Growers Cooperative has negotiated with Tate & Lyle North America Sugars, Inc. to purchase their six sugarbeet factories and associated storage facilities. The Cooperative has agreed to purchase Western for $78 million contingent upon the acquisition of debt financing. The final amount could increase by as much as $25 million if the average bulk Midwest sugar price exceeds 21.75 cents/lb during the next three years. The Cooperative expects to raise approximately $34.335 million through equity investments by its members and approximately $50 million in term loan funds. In addition, it needs to secure an operating line of credit of between $50 million and $80 million. The Cooperative's financial projections are based upon the generation of annual gross profits of $16 million. Nonetheless, if has been difficult to attract term-debt financing at competitive rates because of the risk involved in the investment.
The Rocky Mountain Sugar Growers Cooperative is offering Common Stock and Patron Preferred Stock to sugarbeet farm operators. A prospective member may purchase Patron Preferred Stock for $185/acre, which represents one share. In addition, each prospective member must purchase one share of Common Stock for $100, which represents a membership fee. Ownership of Common Stock entitles a member to one vote for the purposes of managing the cooperative. The Cooperative is authorized to offer 2,000 shares of Common Stock, each with a par value of $1, and 300,000 shares of Patron Preferred Stock, each with a par value of $100 per share. Stock can only be sold to those actually engaged in the production of agricultural products or to other cooperative associations. Landlords who lease land to tenants on a crop-share basis are considered to be engaged in the production of agricultural products. Holders of Patron Preferred Stock are entitled and obligated to deliver the sugarbeets produced on one acre of land per share. If a holder of Patron Preferred Stock is unable to deliver sugarbeets from the subscribed acreage, that owner must arrange for another member to do so.
Rick Dorn is listed as the incorporator of the Cooperative and is the current Chairman of the Board. Nine other producers, with at least two directors of producer marketing associations from each of four states, constitute the rest of the Board of Directors. It is anticipated that the Board would retain Western Sugar's existing management personnel.
Sugarbeet Producer Concerns
As Rick continues his harvesting operations, other producers are preparing for the start of the general harvest season on October 2. Near Laurel, Montana, a sugarbeet producer is pulling his harvesting equipment out of a machine shed and performing scheduled maintenance. Kelly Brester is a typical sugarbeet producer in that he, along with his father, produces approximately 250 acres of sugarbeets per year. He is also one of thirteen directors of the Mountain States Beet Growers Association of Montana, which is the bargaining association for sugarbeet producers living in an eighty-mile radius of the Billings, Montana Western Sugar factory. Historically, the Association has represented growers in contract negotiations with Western Sugar and its predecessors.
Kelly is forty-seven and has been farming and producing sugarbeets since he was eighteen. Like many young farmers, Kelly started by working with his father and renting land on a crop share basis. He continues to rent land, but he has also been able to buy a farm and is currently making mortgage payments on a second one. The replacement value of his investments in specialized sugarbeet equipment is approximately $150,000, although book and salvage values of these investments are quite low. He produces approximately 400 acres of malting barley as a rotation crop. This acreage is contracted annually with Busch Agricultural Resources, Inc. All of his land is flood irrigated either through the use of siphon tubes or gated pipe. In addition to family labor, he hires two or three truck drivers during the malting barley and sugarbeet harvest seasons.
At various times throughout Kelly's farming career, the future of sugarbeet production has been uncertain. For example, in 1984, the Mountain States Beet Growers Association was unable to secure a contract with the pre-Tate & Lyle owners of Western Sugar. That was the only year in the past twenty-eight in which Kelly has not raised sugarbeets (and the only year in the past sixty that his father had not raised beets). Recently, this uncertainty has increased. Over the past two years, it has been apparent that Tate & Lyle wants to exit the industry. The opportunity for producers to buy their processing assets has surfaced during the past year.
Kelly spent several months evaluating his options. Quantitative evaluations of cropping alternatives paint a relatively bleak picture. A decision based solely on a quantitative assessment hinges critically on selected discount rates and net income projections of the cooperative. If the combination of future sugarbeet prices and patronage refunds results in total sugarbeet prices similar to 1996–2000 average prices, Kelly's investment will be worthwhile. Nonetheless, an investment in the cooperative adds risk to an already risky business. Based upon his quantitative assessments and a large dose of “hunch,” Kelly decided to buy shares in the fledgling cooperative. However, not a day goes by that he doesn't worry about the investment. Nonetheless, he recognizes the importance of sugarbeet production on his ability to meet mortgage payments and generate enough net farm income to support his family. He does not see many options available to him at this time. Nonetheless, most agricultural producers are heavily invested in fixed costs. Owning shares in a seasonal processing plant increases those fixed costs and business risk.
As Kelly begins replacing a roller chain sprocket, he contemplates his farming alternatives in the event that sugarbeets are not grown next year. Although sugarbeets have been raised in south-central Montana since World War I, crop production alternatives are generally limited in this area. Malting barley can be a good cash crop if it is contracted with a malting company. However, it appears that such companies are not interested in large expansions of contracted malt barley acreage. Alfalfa hay is an alternative crop that could be profitable in some years. However, large investments in equipment would be required. In addition, alfalfa hay is best grown under sprinkler irrigation rather than flood irrigation. Dry edible beans, corn for grain, and corn for silage can be grown, but often lack local markets. This is especially true for high-bulk forage crops. Prices for feed barley have been low for many years because of relatively large corn harvests in the Midwest. Irrigated wheat generally has low protein content, which often receives significant discounts. To date, soybeans have not been a viable crop alternative in Montana because of relatively short growing seasons.
In addition, if sugarbeets are not a production alternative, farm consolidation will likely occur. That is, alternative crops have smaller per acre margins than sugarbeets. Farm operations will have to get larger to generate sufficient net farm income to remain viable. Therefore, some producers will exit farming and others will likely get larger. Kelly is uncertain if he wants to expand his production operation. Flood irrigation is highly labor intensive and, therefore, expansion of his farming operation would require additional labor resources. Given smaller margins associated with viable alternative crops in the area, he is uncertain if he wants to accept the added risks that go along with additional labor.
Perhaps the largest impact, however, is the effect of the loss of sugarbeet production on land values. It has been estimated that the loss of sugarbeet production could reduce irrigated agricultural land values in Montana sugarbeet producing counties by 20–35% (Taylor). For landowners, this results in a paper loss of equity and, perhaps, reductions in borrowing capacity. However, for those with land and machinery mortgages, the loss of sugarbeet production significantly reduces repayment capacities. In fact, many producers would be unable to continue making scheduled mortgage payments.
As Kelly finishes replacing a roller chain, he wonders if this is the last time he will be performing such tasks given the uncertainty of sugarbeet production in Montana.
Future Directions
As an empty truck pulls even with Rick Dorn's moving John Deere tractor—and the first of 15 tons of beets begin to thump into the truck—Rick contemplates the Cooperative's options. Before any action can be taken, Rick knows that he must have a formal, written plan that can be used to interest alternative financing sources. The plan must
- Indicate whether the sugar industry is an attractive one to enter;
- Discuss the importance of U.S. sugar policy;
- Provide a list of advantages and disadvantages of investing in a cooperative;
- Discuss the financial projections of the Cooperative; and
- Evaluate the long term feasibility of two sugar beet processing companies (Western Sugar and Imperial Holly) coexisting in the same geographic region.
The loud clattering of a slip clutch jolts Rick out of his melancholy and causes him to simultaneously motion to the truck driver, shift his tractor into neutral, and disengage the power to the harvester. He shuts off the tractor engine, climbs out of the cab, jumps to the ground, and walks back to look for the rock that is likely trapped in the harvester, causing the loud noise and halting its smooth operation. He wonders if the noise caused by his recent cell phone call has similarly halted the purchase of the Western Sugar Company and sugarbeet production in south-central Montana.
Comments from the Chairman of the Board
Following the case presentation, the Chairman of the Board of the Rocky Mountain Sugar Growers Cooperative, Rick Dorn, spoke to one group of students in person, and simultaneously to another group via an interactive video connection. Mr. Dorn responded to student comments, answered questions, and updated the group regarding some of the issues posed in the case.
Rick noted that sugar is an important food ingredient because it serves as a sweetener, preservative, and bonding agent. More than forty sugars and syrups are produced by the U.S. sugar industry, and quality is important to food processors. Nonetheless, selling bulk, unbranded sugar within the domestic market is a “street fight” with respect to price. Buyers are very sophisticated, and service is a critical factor for maintaining market share. Sugar processing by-products are important to processor success. Additional efforts have been made in recent years to add value to by-products and extract additional sugar from molasses (desugarization) produced during the refining process.
Rick acknowledged that the purchase of sugar processing assets is risky. Most factories are quite old, and the business environment is very competitive and dependent upon federal legislation. Nonetheless, the loss of sugarbeet production could reduce regional land values by as much as 30%. In addition, growers have invested in developing a brand name for sugar produced by Western. In fact, growers already own 60% of Western's sugar packaging equipment and a large share of their storage facilities. Although 60–70% of Western's sugar is sold in bulk form, Western can store a higher percentage than other companies. Hence, they have a competitive advantage in responding to year-round sugar demand.
Through contractual arrangements, growers have historically shared the costs of packaging, marketing, and selling costs. Western's current labor and management human resource assets will continue to be employed by the Rocky Mountain Sugar Growers Cooperative. Irrigation offers an important competitive advantage to the region's growers. However, this is somewhat offset by lower operating costs of nonirrigated producers in the Upper Midwest region.
Finally, one might question the timing of the Western Sugar Company purchase. As Rick noted, “This is a perfect time in terms of purchasing these assets at the lowest possible price. Waiting until things are going great is a sure method of paying top dollar. In addition, opportunities do not always surface at perfect times.” In fact, sugar prices had recently started to rise, and prospects for favorable sugar provisions in the new farm bill appeared strong. Negotiations were being held in which seller financing by Tate & Lyle is being pursued. Nonetheless, Rick noted that the presence of two sugar processing companies within the same region is not likely to be sustainable because neither company will likely be able to contract enough acreage from regional growers to efficiently run all factories.
As a conclusion to the discussion, Rick asked for a show of hands of those who thought that producers should not purchase Western Sugar because of the riskiness of the venture. Approximately one-half of the students raised their hands. Rick smiled and noted that a similar percentage of producers would probably agree with the students.1
Acknowledgments
The authors have prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. The cooperation and contributions made by Rick Dorn, Kelly Brester, and members of the Rocky Mountain Sugar Growers Cooperative are greatly appreciated.
