I was looking for interesting small/midcaps. In this process, I first do some basic screening to get some candidates to dig further into. One of my criteria was having a low price/free cash flow. In the best of days, any of the candidates coming from such criteria would have to be inspected with a fine comb, as this is the kind of criteria that digs up a lot of hopeless situations.
It wasn't really the case with the company I was looking at, though. Here I had a little company whose main business was building power plants for other people. The company was Argan (AGX). It built natural gas fired powerplants, wind, solar, etc. Given the present environment it didn't seem like a bad business. It was not like it was selling machinery to coal mines …
Since I had searched for low price/free cash flow, obviously it had it in spades. Indeed, for a market capitalization of $208.5 million, it had generated around $100 million in free cash flow in just the last 12 months. And then there was an even bigger surprise to be had. The company also carried $175 million in cash, and was trading at a forward P/E around 10.2. If I was just to take these numbers at face value, this had to be a no-brainer.
But one needs to look at the SEC filings!
Screening is not enough. One has to kick the tires on these candidates. To look at the SEC filings. I did so, and it wasn't long before I started seeing why the free cash flow was so high, and why there was so much money in the balance sheet. And it wasn't due to the company making gobs of money - though it really was profitable.
Basically, although the firm had a level of profitability - gross margins were 15.9% in the last quarter - that couldn't account for all that cash and free cash flow. What happens is that these projects the company undertakes are quite expensive, and the company managed to bill quite a bit in excess of the costs it has already sunk into the projects. The latest 10-Q shows this effect:
So although Argan could still be an interesting prospect, most of that cash pile was on borrowed time - little more than float that would be gone once the projects were concluded with their rather meager profitability. It was no longer an incredible find, but just your regular company whose true EV/EBITDA, if we removed the effect of this cash, would be more like 6.2 than the <2 bargain that it seemed before.
No matter how much screening we do, we always have to take a look at the SEC filings in the end. Argan, which first seemed like an incredible bargain if I were to trust just the screening, ends up being a regularly valued company.