QUAKER CHEMICAL CORP. $23 (New York symbol KWR; Income Portfolio, Manufacturing & Industry sector; Shares outstanding: 10.0 million; Market cap: $230.0 million; WSSF Rating: Average) is a small company that is prominent in a small industry. It makes lubricants and specialty chemicals that protect industrial machinery from corrosion.

It sells these products mostly to steel, automotive and appliance makers in the United States and Europe. Overseas markets account for 55% of total sales.

Most investors have probably never heard of Quaker, and few brokers cover it. But the company is a leader in its niche markets, and has a long history of rising sales and earnings.

Sales rose from $274.5 million in 2002 to $460.5 million in 2006, or 13.8% compounded annually. Profits before unusual items crept up from $1.51 a share in 2002 to $1.52 in 2003. Earnings fell to $0.70 a share in 2005, but lower costs due to a restructuring expanded profits to $1.08 a share in 2006.

Coping with higher oil prices

Quaker needs oil to make its products, so it’s vulnerable to rising oil prices. It cuts this risk with contracts that lock in prices for up to one year. Thanks to its high-quality products, Quaker is able to pass along most of its higher raw material costs to its customers.

The company now aims to cut its reliance on bulk sales of lubricants. Its Chemical Management Services division helps customers install and manage certain equipment, for a fee.

Since forming this business four years ago, it now has long-term contracts with General Motors, Ford and DaimlerChrysler. High profile deals like these should help it win more outsourcing contracts.

Quaker also hopes to spur sales with new investments outside of North America. It recently acquired the minority interests of its affiliates in China and Brazil. Full ownership will make it easier for Quaker to expand these operations, and take advantage of rising overseas demand for its products and expertise.

Debt still reasonable after big jump

The company had to borrow the cash it needed to complete these acquisitions. That raised Quaker’s longterm debt from 12% of stockholders’ equity in 2004, to 82% this year. But that’s reasonable in light of the strong earnings potential of these investments.

Despite higher interest costs, Quaker should be able to keep paying its $0.86 dividend, which yields 3.7%. However, dividend increases may be slow to come. Instead, the company will probably use any extra cash flow to pay down debt.

The stock now trades at 17.0 times its 2007 profit estimate of $1.35 a share. It’s also appealing at 8.8 times its likely 2007 cash flow of $2.60 a share, and at just 48% of its sales of $48 a share.

Rights plan hampers takeovers

Quaker’s small size and growing profitability would seem to make it a strong takeover candidate. However, its stockholders’ rights plan prevents anyone from acquiring more than 20% of its outstanding stock without first securing management’s approval.

Quaker Chemical is a buy.