I think I have found a stock that could reward shareholders
with a double in stock price sometime within the next 2 years. ICO Inc. has the right combination of business
strategy, management, growth opportunity, right environment and a discounted valuation
to get you there.
ICO Inc. manufactures specialty resins and concentrates and provides specialty
polymer services, including size reduction, compounding, and other related
services. ICO's operating facilities are
strategically located to place its products, sales force, and technical
expertise within reach of its customers, which include chemical companies,
manufacturers of plastic products, and production affiliates of major oil
exploration and production companies.
Why I like management:
In my few phone conversations with Jon Knapp the CEO, I have
been most impressed. Jon owns about 4.9% of the company.In my doing due diligence, I quickly realized
that Jon understood how to build value for a company.He is very cost-conscious, and is very
focused. Jon became the CEO in 2005. These are the selected numbers and
contrast them with the years before he took over.
Compensation philosophy: ICO holds senior management a modest base
salary well below peers but has a robust bonus plan driven by metrics, which
shareholders should find attractive. These metrics include growth in
operating income, return on invested capital, investment turnover and return on
In every conference call, Mr. Knapp repeats a few lines - that he is a gross
margin fanatic and a stickler for return on invested capital. This culture,
coupled with the compensation philosophy has permeated all throughout the
company and the results are in the pudding. Return on assets went from 0 to
9.5% in three years since he became CEO and there is ample opportunity for
improvement.Year over year revenue
growth for the past quarters range from
15 to 42% . By acquiring used equipment and fabricating and upgrading it,
ICO lowers its cost of operations and reduces its capital costs by over 50%
without sacrificing quality of the output.
Management has indicated its goal of reaching 20% gross margins from its
current 17% in 2 to 3 years. How so? Instead of trying to be a genius and apply for as many patents as possible, management is following a
very sensible strategy of working closely with their multinational customers to
help them develop products that utilize ICO's core competency in processing
polymers and that capitalize on ICO's presence in 19 locations in 10
countries. In the framework of Michael Porter's study on competitive
strategy, this approach of working closely with customers to come up with unique and
non-commodity products creates a lasting, sustainable competitive advantage.
The value ICO delivers to their customers in turn rewards ICO with higher gross
margins. Furthermore, they are selective with which customers they work
with to satisfy their 20% gross margin target. They have chosen the oil
and service industry as one of the industries to focus on. For example,
recently they have developed polymer powders used in cementing oil wells.
Over 60% of the company's revenues are outside of the U.S. They just opened a plant
in Dubai and another plant in Malaysia in late 2007. They also
have a location in Brazil.
All these geographic regions are benefitting from strong growth. Furthermore,
if you believe in the long-term thesis that the dollar is going to go weaker
(as I do) unless the U.S.
controls its current account deficits, the current environment should be good
for ICO's momentum. I am a strong believer that with rising current account
surpluses and dollar reserves, countries outside of the US will have a much more favorable economic
growth picture at least for the next 2-3 years and so, companies that have a majority of their
revenues coming from outside the U.S.A.should have better growth opportunities, all other
things being equal.
ICOC cleaned up their balance sheet by redeeming the preferred shares in
2007. They added to their debt but by my calculations they should have free
cash flow of about 7 Million in 2008 and 14 Million in 2009 to pay down debt.
As it stands right now:
Market Cap is 27 Million shares x 9.93 (stock price) = 268 Million
Total Debt of 68 Million
Cash 4 Million
Total debt is 64 Million. Enterprise
Value = 332 Million
Trailing EBIT = 31 Million
In today's earnings release, revenue grew by 29% YOY
and Operating Income grew another 51% YOY. Gross margins were 17.2%. Company’s
outlook remained positive for the upcoming quarter.
What would you pay
for a business with double-digit EBIT growth, great management, right focus and
Given the fact that their Malaysia
plant and Dubai
plant operations will have its first full year of operation this year, let us
just halve this 50% growth, and assume EBIT grows by 25% in 08 and 15% in 09.
Management has an objective of 20% gross margins, I suspect they can get better
than that by 2010. If revenues are to
grow 20% in 2008 and 2009 and gross margins are to go up to 20%, by 2010
you are looking at a company with revenues of 655 Million, with EBIT
margins of 10% which equate to 65 Million. Let us assume they use their
free cash flow to pay down 20 Million of their debt. Capitalizing it at 10 times EBIT, you will get
a stock price of about $23 a share between now until end of 2009, that’s 130%
from where the stock closed at today.
Frankly, under normal circumstances, I will not be as comfortable with my
margin and growth assumptions, but I make an exception in this case because I
believe management here is very good and I have conviction that they will
deliver. You can read their earnings press releases, 10ks and 10qs and
their conference call transcripts to see if you agree with me.