Argan (AGX)

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Key Statistics

Enterprise Value = $184.8 million

Operating Income = $82.77 million

EV/Operating Income = 2.23x

Earnings Yield = 10%

Price/Revenue = .68x

Debt/Equity = 0%

The Company

Argan is a holding company that operates in the construction & engineering space. The focus of their business is the construction and operational support of power plants. The company has expanded over the decades and acquired other businesses in the same space.

The power plant business is the core of the company and also a source of uncertainty. Out of $675 million in revenues in 2017, the power plant business supplied $586 million of it. Other areas that Argan operates in include industrial fabrication and a telecommunications infrastructure business.

They have been in business since 1961.

A textbook example of Argan’s power plant business is their Panda Liberty Project in Pennsylvania. The project was completed in 2016. It was probably first negotiated in 2011-2012. Permits were then obtained, and it took 3 years to build. It is a small power plant running on natural gas and supplies electricity to 1 million people in Pennsylvania. It shows the nature of Argan’s business: (1) smallish power plants, (2) long time horizons for projects to come together, (3) a specialty in natural gas power production.

Argan acquired a nice book of natural gas power plant business with the decline (and abundance) of natural gas that came about as a result of fracking in the United States.

Sentiment

Argan has been punished in the last year, with the stock down 43% for its levels a year ago. The valuation statistics (2.23x EV), as you can see above, are down to absurd levels. It’s one of the cheapest stocks in the market by several metrics.

If it’s so cheap, what’s the problem? Simply put, the market is concerned that Argan doesn’t have a deep project backlog and won’t be able to continue generating its current level of earnings power. The business is already drying up, with year over year earnings declining by 65%.

Adding to the uncertainty is declining electricity usage in the United States. Electricity usage in the US is actually down since 2010 through a combination of technological efficiency and recession. While electricity use typically declines during recessions, it hasn’t recovered in a typical manner. Previously in the United States, economic growth and energy usage were tied at the hip. This relationship appears to have broken down as technology increases efficiency. As our TVs no longer require a crew of guys to move and refrigerators no longer guzzle electricity, the US economy has been able to grow without increasing electricity usage.

While the more efficient use of energy is likely good for society as a whole, it is terrible news for Argan, as the thirst for electricity (and power plants) isn’t what it used to be.

My Take

While Argan’s future is uncertain, the balance sheet’s quality is crystal clear. Argan’s balance sheet is a fortress. Management clearly expects business to be choppy (power plants don’t sell like candy bars) and prepares accordingly. They have zero long-term debt and a massive cash stockpile, currently at $434 million, or $27.88 per share. This is nearly equal to the market capitalization of the entire company.

While the future streams of business are uncertain, I am encouraged that Argan has been in this business since 1961. They have survived numerous recessions and downtrends in the industry. It seems foolish to think that they won’t overcome their current problems. My expectation with this stock is that they will find new sources of business as they always have, which should send the stock soaring once it comes together.

Electricity consumption might be declining, but this certainly does not mean that Argan’s business is dead. Plenty of power plants are in need of replacement. It might surprise and shock people to know, for instance, that there are still 1,300 coal power plants operating in the United States. Most of the nuclear power plants are also aging because they are mostly over 40 years old and some of them will need to be replaced as well. (We stopped building nuke plants after everyone was freaked out by the three-mile island incident. The China Syndrome didn’t help either. So, we stopped building nuclear power plants to our own detriment as a society.)

Alas, this blog isn’t about saving the world, it’s about making money. There is a large number of dirty, old power plants that will need to be replaced in the United States and that should generate business from Argan. The key to Argan’s future prospects is the generation of new business, which is bound to come.

Natural gas prices also remain cheap (for now), which likely means that Argan’s specialty in this area will be in demand.

Most importantly, even if they don’t find new sources of business, the balance sheet offers protection on the downside. It also makes me conclude that the position won’t blow up in any kind of spectacular fashion. The company is nearly trading for the cash in the bank, which is absurd.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.