Rising Star Buy: A Diversified Small-Cap Bargainhttp://www.fool.com/investing/general/2011/09/15/rising-star-buy-a-diversified-small-cap-bargain.aspx Rex Moore
September 15, 2011
This article is part of our Rising Star Portfolios series.
One of the best things about screening (and this is a portfolio based on screening) is uncovering great companies that would normally fly under the radar. Today, thanks to my Modified Foolish 8 screen, I'm announcing my intent to buy a small, underappreciated company in a boring market -- LSB Industries (NYSE: LXU ) . I think if you can stay awake through the business description, you'll find it's a compelling value.
LSB operates a great business that's pretty easy to understand. It has two main segments:
Climate Control (41% of 2010 revenue)
Chemical (58% of 2010 revenue)
The demand in all three of these markets is such that LSB is running all four of its chemical plants -- in Arkansas, Alabama, Oklahoma, and Texas -- at optimal production rates.
Source: Capital IQ, a division of Standard & Poor's.
Why I'm buying
One criterion that knocks out a lot of contenders is the requirement for return on equity of 15% or greater not only for the last four quarters, but the last three fiscal years as well. This kind of consistency in LSB's case points to strong management and solid competitive advantages.
For Climate Control, this is a function of a flexible manufacturing process that allows for custom designs, the tailwind (and tax breaks) of the geothermal "green" movement, and a 38% share in that geothermal market. For Chemical, it's location advantages for the geographic regions it serves, which allows for lower freight and distribution costs than competitors. These factors all help contribute to the high margins.
Strong management is another factor in my purchase decision. The team is led by founder, CEO, and 12% owner Jack Golsen, who has ably guided the company since it started up in 1968. No doubt influenced by the credit crisis, management has strengthened the balance sheet, which now has more cash than debt and a debt-to-equity ratio that has plummeted downward from over 100% in 2007 to an appealing 26%.