On October 23, 2019, we wrote an article entitled, Argan (AGX): A Natural Acquisition Target (to see the article click here). This is a brief follow-up article to our overall thesis that Argan is undervalued and a perfect acquisition target. We shall also look to go beyond the numbers of the 4th quarter as reported on Wednesday, April 10th.
In this article, we will look at Argan's highlights from the quarter- and year-end filed on 4/10/2019. After listing these highlights, and expanding on Argan's backlog (a key metric in valuing Argan), we outline what we see as the opportunity created for us diligent investors if we look beyond the numbers. We follow up with a valuation of Argan to justify our target price.
For a copy of Argan's 10-K filed on 4/10/2019 please click here.
Highlights from 2019 year-end:
- Gross margins increased to 17.1% versus 16.7% for the prior year.
- GPS revenues decreased to $482M vs. $892M last year which was expected due to the decrease in backlog last year.
- Other units doubled in aggregate at its other operating units.
- EBITDA of $52.5M vs. $116M.
Key highlight - backlog:
Argan's backlog now sits at $1.1 billion vs. $379 million last year. This does not include Chickahominy Power Station project which we believe will add another $750 million to the current backlog. When the stock traded at $75 back in the first quarter of 2017, the backlog was less than $1.1 billion.
Please note that KORR has been following the permit approval process for the Chickahominy Power Project, including the comments (the period for comments ended on March 20,2019 see article here) and we see NO reason why the permit will not be granted within the next 60 days. The project, in addition to awarding the EPC contract to GPS, has selected a unit of Mitsubishi (OTCPK:MSBHY) for its turbines (see article here).
The opportunity is in the hidden value we discover when we look past the $1.1 billion backlog; and read from the company's 10-K, about an EPC award, the Chickahominy Power Project, that has yet to be added to the backlog.
We know that since Argan has not formally been given the "Letter to Proceed," Argan has not counted Chickahominy to its backlog. But, Argan gives us diligent investors the information we need when they state in their 10-K the following:
"Currently, we are participating in developmental and related financing activities with several developers, including the consolidated variable interest entity created to develop the Chickahominy Power Station which is planned to be built in Charles City County, Virginia. In June 2018, we announced that GPS has been awarded the EPC services contract for this 1,600 MW gas-fired power plant. Among other tasks, the efforts of the developer to obtain final regulatory permits and approvals and to secure financing for this power plant, which are essential for the completion of the development phase of this project, are currently underway." - Source 10-K filed on April 10, 2019
What does this backlog mean?
According to the company (call dated 4/11/2019), if Chickahominy is added to Argan's backlog, AGX's backlog will be at the highest level in its history. To give us some perspective, Argan's stock traded over $75 during the first quarter of 2017 when the company's backlog was approximately $1.1 billion (same as today's level). We see this backlog solidifying revenues and earnings for shareholders for the next 3 years. With Argan trading at current levels, we believe Argan is a perfect acquisition target. AND, we believe, it will only be more so, as their backlog climbs over $2 billion in the next few months (we predict that Chickahominy will at approximately $650-750 million alone, and there are others that are within the company's sites).
An acquisition valuation:
On October 22, 2018, Jacobs Engineering (JEC) announced the sale of its energy, chemicals and resources business to WorleyParsons (OTCPK:WYGPY) for $3.3 billion. This deal garnered an 11.5x trailing twelve-month adjusted EBITDA of Jacobs' units. If we apply the same multiple to Argan's normalized EBITDA of $100 million and add its net cash, it would equate to a share price of over $92/share (see "By the Numbers" below). Today, Argan trades at ~$50.50.
With the current and awarded contracts equaling a backlog of almost $2 billion, we see Argan having a margin of safety of ~50% on a fair acquisition valuation.
For an explanation of the term margin of safety click here.
- EBITDA: a normalized EBITDA of $100 million
- Shares Outstanding: 15.7 million
- Long-Term Debt: Zero
- Cash and Cash Equivalent: $297 million (latest quarterly report)
- Multiple of 11.5x EBITDA (normalized): $1.15 billion
- EV would therefore equate to $1.15 billion + $297 million = $1.447 billion
- $1.447 billion/15.7 million shares outstanding = $92.16/share
If we compare the above numbers to the three deals done in the last 2 years, we see that Argan offers an attractive takeover. In addition to the numbers, Argan offers a low-risk acquisition to an acquirer.
Argan, an Acquirer's Dream
As we have highlighted above, the numbers including cash on hand, clean balance sheet, backlog, enterprise value to normalized EBITDA multiple, all are attractive. But there is more to an acquisition than numbers.
Structure of Argan
Argan is set up as a parent company with wholly owned subsidiaries. This structure provides flexibility to a potential acquirer to dispose of businesses they may not want or to better incorporate those subsidiaries into their own structure.
For the large players, looking mostly at Gemma, the business in both revenues and earnings for Argan, the most important factor is reputation. Argan is known for its quality of work, its ability to tackle tough engineering complexities, and finishing projects on time. Finishing projects on time is of utmost importance to power companies which enter into take or pay contracts with grids and face tremendous penalties for failing to supply power they contract to provide.
A key competitive advantage, and one that can be exploited by a large acquirer like Fluor (FLR) with a $29.1 billion backlog in its various EPC business segments (Source: FLR investor presentation 5/11/18) is Argan's flexible workforce.
Safety record - low risk
Argan also has a terrific safety record, having incurred no lost time injuries in 7 of the last 10 years, and its recordable injury rate is significantly below OSHA's reported national average (Source: Argan's investor presentation dated 9/5/18).
Argan maintains an excellent balance sheet. Argan and a potential suitor could benefit when bonding projects, cost savings on accounting, sourcing and other low hanging fruit.
- Large project and customer concentration creates both a lumpiness and a financial risk to Argan. GPS, Argan's largest operating unit, only has a handful of projects that account for all of its revenues and earnings.
- GPS primary business is building gas fired power plants. While the overall US and international trend has been to close down or convert coal power plants in favor of natural gas plants, recent US policies have been more lenient on the shift away from coal.
- Regulatory - Mercury and Air Toxics Standards (MATS) and Clean Power Plant rules are changing regularly, and environmentalists often object to gas powered plants versus greener alternatives such as wind and solar.
- Project execution risks, while minimal, are still there.
We are long Argan. We are raising our price target to $75/share (see the previous article) because we believe Argan, independent of a takeover bid, will garner a fair multiple once it books the additional backlog. We look forward to more contract wins, a beefed-up backlog, possible acquisitions or investments; but above all, we look forward to Argan hitting our price target of $75 in the next six months.
Disclosure: I am/we are long AGX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article should not be considered investment advice. Readers are encouraged to consult their own investment advisor. We reserve the right to sell or hedge our position without updating readers.