LTHM - Argan: Shares Are Cheaper Than They Appear

2023-12-11 08:10:22 ET

Summary

• Today, we take a look at power generation contractor Argan, Inc., which has been somewhat volatile lately due to uneven quarterly performances.
• The company operates in the power industry, industrial construction, and telecommunications infrastructure services sectors.
• Argan's balance sheet is strong and pristine, with no debt and a dividend yield of over 2.8%, and the shares have seen some recent insider buying.
• A full investment analysis around Argan, Inc. follows in the paragraphs below.

Electricity is really just organized lightning ” ? George Carlin

Shares of power generation contractor concern Argan, Inc. (AGX) have been volatile lately. The company had a solid second quarter, which was followed by a disappointing third quarter, whose results came out this week.

With generally unstable backlogs, but with a pristine balance sheet and a 2.8% dividend yield, the recent insider buying merited a deeper dive. A full investment analysis follows in the paragraphs below.

Company Overview:

Argan, Inc. is a Rockville, Maryland based construction firm primarily offering power generation, industrial, and telecommunications infrastructure services in the U.S., UK, and Ireland. Through its four subsidiaries, it provides engineering, procurement, construction, commissioning, maintenance, project development, and technical consulting to public utilities, industrial concerns, and government agencies.

Argan was incorporated in 1961 as Puroflow and went public in 1995 at $3.50 a share, after giving effect to a 1-for-15 reverse stock split in 2001. It reorganized as a holding company and began making acquisitions in 2003. Its stock trades just over $42.00 a share, translating to an approximate market capitalization of $565 million.

The company operates on a fiscal year (FY) ending January 31st. For the avoidance of doubt, the twelve-month period ending January 31, 2023, is FY23.

Operating Segments

Management views its operations through three segments: Power Industry Services (PIS); Industrial Construction Services [ICS]; and Telecommunications Infrastructure Services [TIS].

PIS builds gas-fired power plants, biomass facilities, solar energy and wind farms, and waste-to-energy plants. It is comprised of two subsidiaries: Gemma Power Systems, a large-scale power generation project construction firm that was onboarded in 2006; and Atlantic Projects Company (2015), an installer of turbine, boiler, and large rotating equipment, as well as a provider of attendant commissioning and outage services. PIS generated FY23 income from operations of $46.0 million on revenue of $346.0 million, or 76% of Argan’s total top line. It should be noted that over the past three fiscal years, one project (Guernsey Power Station – the largest single-phase gas-fired power plant project in the U.S.) accounted for more than half this segment’s revenue, although only 38% in FY23 as it neared completion.

ICS consists of The Roberts Company, a construction and field services concern with steel pipe and plate fabrication capabilities, predominantly handling projects in the Southeastern U.S. Founded in 1977, The Roberts Company was acquired by Argan in 2015. From customers that include Weyerhaeuser ( WY ) (forestry products), Livent ( LTHM ) (lithium), and Nutrien ( NTR ) (fertilizer), ICS produced FY23 income from operations of $6.8 million on revenue of $92.8 million, representing 20% of the company’s total.

TIS is comprised of Agran’s Southern Maryland Cable Infrastructure Solutions subsidiary, a provider of utility construction services and wiring solutions to customers in the MidAtlantic region of the U.S. Its capabilities include design, testing, and maintenance of fiber-optic communications systems. Onboarded in 2003, TIS generated a loss from operations of $0.4 million on revenue of $16.2 million, or 4% of Argan’s total.

Not all the company’s projects are performed in the U.S., with PIS work in Ireland (15%) and the UK (13%) contributing to its total FY23 top line of $455.0 million.

Recent Operating and Stock Price Performance

With Argan’s PIS segment tackling large-scale construction projects such as Guernsey and accounting for more than three-quarters of its FY23 revenue, it is unsurprising to learn that the company’s top line is subject to lumpiness, inconsistency, and unpredictability, with share price performance a function of (or reaction to) backlogs and new contract news hitting the tape. The past seven years are a case in point. After generating FY17 (ending January 31, 2017) revenue of $675.0 million, Argan produced a record FY18 top line of $892.8 million, as it was able to leverage its gas-fired power plant construction competencies into six major contracts. As these projects completed and were not fully replaced, revenue declined 46% to $482.2 million in FY19. A delay at the aforementioned Guernsey project contributed to FY20 revenue plummeting another 50% to $239.0 million. After peaking at $72.90 in 2017, shares of AGX plunged 48% over a six-month period (October 2017 to April 2018) on a significant decline in backlog (~$1.2 billion to ~$500 million) over the course of calendar 2017, portending the future revenue declines. After that selloff, Argan’s stock has primarily traded between the mid-30s and mid-40s (with two brief exceptions), as revenue rebounded 64% to $392.2 million in FY21 and another 30% to $509.4 million in FY22. That was followed by an 11% drop to $455.0 million in FY23, the fiscal year in which Founder, Chairman, & CEO Rainer Bosselmann retired.

2QFY24 Financial Report

With that demonstration of inconsistent revenues as a backdrop, Argan reported 2QFY24 financials on September 6, 2023, posting earnings of $0.94 a share (GAAP) and EBITDA of $17.9 million on revenue of $141.3 million versus $0.30 a share (GAAP) and EBITDA of $14.9 million on revenue of $118.1 million in 2QFY23, representing improvements of 213%, 21%, and 20%, respectively. On the surface, the performance was impressive, but the gross margin was 16.8%, down from 20.6% in the prior year period – a function of greater contribution from less risky, lower-margin time-and-material contracts (vis a-vie fixed-cost). The increase in earnings was wholly due to higher yields from invested cash ($0.27 per share improvement) and lower tax expenses ($0.38).

The all-important backlog was essentially flat at $824.0 million on July 31, 2023, versus $822.0 million on January 31, 2023, buttressed by the Shannonbridge Power Project in Ireland that commenced in August 2023 and three Vistra Solar projects in Illinois. Approximately five-sixths of the backlog supports the transition to ‘ cleaner ’ energy solutions. However, management hinted of a near-term reduction in backlog (presumably 2HFY24) followed by a meaningful bump higher from current levels – presumably in FY25.

Even though the GAAP earnings were a function of non-operational improvements, the market reacted positively to the report, bidding thinly traded shares of AGX 9% higher in the subsequent trading session to $44.58.

Third Quarter Results:

Unfortunately, the company could not duplicate the solid results in the second quarter when it reported Q3 results this Thursday. Argan delivered a GAAP profit of just 40 cents a share, less than half the expected profit. Revenues did rise nearly 39% on a year-to-year basis to just under $164 million, some $3 million above the consensus. Order backlog fell to $730 million from $824 million at the end of the second quarter.

Management blamed the big earnings miss ' on the difficulties with completing work on the Kilroot power plant in Northern Ireland which stopped generating electricity from burning coal at the end of September '. The gas-fire replacement is due to begin operation next year leadership and profitability was solid from the rest of Argan's operations they also noted.

Balance Sheet & Analyst Commentary:

One item the market can be constructive on is the company’s balance sheet, which held cash and investments of just over $395 million and no debt on its balance sheet as of the third quarter. Argan returns capital to shareholders both in the form of a $0.30 quarterly dividend (current yield of 2.84%) and a share repurchase program. As for the latter, management bought back 169,788 shares (slightly more than 1% of the total outstanding) in 1HFY24 – every time (it appears) its stock dips below $40. The company bought back an additional $1.7 million worth of stock in the third quarter.

CJS Securities and Lake Street seem to be the only analyst firms covering this equity at the moment. Lake Street reissued its Buy rating and $61 price target on AGX on the same day Q3 results were posted. On average, they expect the company to earn $2.64 a share (GAAP) on revenue of $570.4 million in FY24, followed by $3.32 a share (GAAP) on revenue of $649.7 million in FY25.

Board member Cynthia Flanders is also bullish on Argan’s prospects, purchasing 15,500 shares between October 5th and October 12th. This is the only insider activity in the stock so far in 2023.

Verdict:

Owing to its inconsistent revenue generation driven by large projects, the company will likely never command a market multiple. Attempting to ascertain upside potential is a function of its ever-uncertain pipeline as it pursues natural gas-fired power plant, renewable energy, and industrial construction opportunities in the U.S., UK, and Ireland. Argan is not abnormally cheap on a PE basis, trading at 16x FY24E EPS. However, due to its pristine balance sheet, its EV/TTM EBITDA ratio is more compelling at under six.

That said, neither of these metrics screams ‘buy’. Still trading near the higher end of a six-year trading range, the recommendation is to keep the powder dry until shares of AGX trade under $40, where the company is a buyer of its low-volume stock.

I'd say we're all just ghosts on a wire seeking the prick of an electric thought .”? Robert Fanney

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