February 08, 2008 - 1:44am EST by
2008 2009
Price: 9.93 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 270 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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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.

Core competency:
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.

                                 2003  2004  2005 2006 2007
Revenue Growth         13.9   24.6  15.2    9.4  28.9
Operating Income        -22.6   5.2  8.2    21.3  29.8
ROE %                       -56.3 0.37  6.1    14.2  23.1

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 equity.

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.

Right strategic focus:
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.

Balance sheet
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

Trailing Revs = 418 Million
EV/Sales = 0.73
EV/EBIT = 10

Today’s Earnings Release:

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 multinational presence?

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.





Conference call webcasts:


Today’s earnings release:



When analysts start covering the stock
Growth at this value will soon be noticed
Continued pay down of debt
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