CHPT - Argan Faces Headwinds In 2024 But Will Likely Prosper In The Long Run

2023-12-13 00:23:48 ET

Summary

• Argan's subsidiary APC faced challenges in the construction of the Kilroot project, resulting in a significant hit on gross margins.
• Argan reported mixed Q3'24 operating results with declining margins but exceptional top-line revenue generation.
• Despite short-term headwinds, Argan is well-positioned for the future of energy transmission and has a strong backlog supporting the low-carbon economy.

Argan ( AGX ) experienced mixed q3’24 results as their subsidiary APC encountered significant challenges in the construction of the Kilroot project. Aside from this $11.5mm hit on gross margins YTD, Argan reported mixed q3’24 operating results with exceptional top-line revenue generation with declining margins. Excluding the Kilroot project loss, Argan would have reported $29,935k in gross profit with an 18% margin when compared to the GAAP $19,235k with a 12% margin. Given these short-term headwinds and the macroeconomic landscape for CY24 as well as the shareholder value management brings to the table through buybacks and dividends, I reiterate AGX a BUY recommendation with a price target of $65.66/share.

Macro & Operations

The macro picture continues to look bright for Argan in the long run as McKinsey projects energy investments to increase from $1.5t in 2021 to $2-3.2t in 2040. In aggregate, McKinsey anticipates overall fossil fuels to begin a sharp decline beginning in 2030 primarily resulting from coal-fired power plants being phased out with natural gas remaining stable.

McKinsey goes on to discern what they expect the power mix to look like going forward based on current trends.

Overall, Argan is well-positioned for the future of energy transmission with its deep bench of expertise in natural gas, wind, and solar. As of q3’24, 82% of Argan’s backlog supports the low carbon economy, 72% of which is in natural gas.

Argan’s q3’24 performance was significantly affected by operational and contractual challenges relating to the Kilroot project. As the firm ground its teeth on an $11.5mm hit to gross profit due to project delays, the project remains 95% completed as the facility is expected to commence operations in early CY24.

On a more positive note, Argan’s subsidiary Gemma received limited notice to proceed on 3 solar and battery storage projects for Vistra Corp. ( VST ). In total, as announced in September 2021, Vistra anticipates investing over $550mm to build the Coal to Solar & Energy Storage Act Portfolio in Illinois with all projects expected to enter commercial service by 2025. Argan’s projects for Vistra represent 53% of their solar capacity and 15% of their battery storage capacity.

Argan experienced an 11% reduction in their project backlog as the firm converted a portion of the backlog to revenue through the completion of milestones for the Guernsey Power Station and Maple Hill Solar facility. Each of these projects should be closing out by the end of q4’24. Management discerned that no major projects were added to the backlog during q3’24. The firm recognized $164mm in revenue from its backlog with $70mm in smaller projects offsetting this decline.

It will be challenging to project out new project backlog as the current economic environment makes for a challenging market for new renewable installations. As discerned in my article covering ChargePoint ( CHPT ), rising financing costs have created a challenging environment for major projects outside of larger, self-financing firms.

It’s taking longer than the market expected initially for the IRA benefits to kick in,” said James West, a senior managing director at investment bank Evercore ISI, who analyzes clean-energy companies. When they do emerge, “they’re accruing to companies that are more mature and more established and don’t need to raise capital.

- WSJ

These changing economics significantly clash with my initial thesis on Argan as I anticipated faster project financing through the major infrastructure development bills, including the IRA and the Infrastructure Bill. I do believe Argan will be able to capitalize long-term on the transition from coal-fired power plants to natural gas-fired power plants and renewable energy sources; however, major project development may not be implemented until interest rates come down.

On a GAAP basis, profitability has taken a slight drag as the firm navigated through higher inflationary pressures across segments.

Valuation

Argan repurchased 43,000 shares of common stock for $1.7mm with an average price of $40.54/share during q3’24. Management also increased their cash dividend payout by 20% to $0.30/share this quarter for an annualized payout and yield of $1.20 and 3%, respectively.

On a tactical basis, the stock appears to have some room to pull back before entering a bullish multiyear upcycle. Considering the RSI reading maintains an overbought signal, the stock price may pull back to the high $30s to low $40s before turning to a bullish uptrend. This cycle maintains the macro narrative that interest rates are expected to begin to decline in CY24 as inflation continues to taper down. There are some negative economic reads that may lead the Fed to act sooner rather than later. The Manufacturing PMI for November 2023 came in at 46.7%. The report suggests new orders, backlogs, employment, and production all contracting with inventory destocking taking place. It’s clear that Argan’s backlog for q3’23 resulted in a similar effect. How long new orders and backlog remain in contractionary territory may be a direct result of the anticipated rates cut in which project financing is purposefully being delayed until cheaper financing becomes available.

As for AGX shares, I believe the headwinds have been baked into the share price for the last year as the firm has remained in value territory. Given that the biggest sticking point in project financing relating to the IRA is the cost of financing, I believe that the loans as guaranteed through the IRA may be the safety net IF the Fed acts by lowering key rates and project financing becomes cheaper and more widely available. Long-term, I maintain my BUY recommendation with a price target of $65.66/share.

For further details see: