Argan Stock: Positioned With Respect To Energy Situation

As the quest for energy production and supply is continuing, we may want to consider a construction and engineering company with a strong presence in the power generation sector. Argan (NYSE:AGX) fits the bill as it is a holding company with four fully owned, established subsidiaries in the energy construction sector that provide it an in for the latter stages of the renewable push and a good deal of vertical integration. It provides a full range of engineering, construction and procurement services. Most of the AGX projects are in the U.S., however, there is a new project in Ireland and the UK for 3 power plants which give AGX a small, but under the present political circumstances, an important international presence. With expertise that doesn’t put it behind the times and an alright multiple, Argan is worth following, although the retreat of CAPEX cycles is a reason to maybe stay on the sidelines as order intake might suffer.

Vertical Integration

Argan has several subsidiaries that have been acquired over the last couple of decades that provide it with vertical integration and also some expertise into assets that explicitly fit the endgame of the green agenda. Gemma Power Systems is involved in procurement and construction of power generation systems both conventional and using renewable energy. Roberts Fabrication designs and produces plant components such as pipes, pressure vessels, heat exchangers and is also involved with plant maintenance, which allows for more recurring and higher margin revenue even after projects are complete. Atlantic Projects is a construction and engineering company based in Ireland which builds power generating facilities which are operated by using gas and oil, as well as various industrial process facilities. SMC Integrated Systems is a company which installs wiring, cable and power transmission systems in large institutions such as hospitals, military facilities and transport hubs. The international presence in Ireland is welcome where three 65 MW conventional power plants are being constructed through a new contract by Atlantic Projects, providing a reliable future income stream to add to the 4% of overall revenue attributable now to Ireland and adding to the $340 million backlog. It is also a platform for more engagement in EU markets, where American share of revenue is currently 86%.

Renewable Transition

The main source of AGX revenue is the building of gas-powered power plants in the USA, Ireland and UK. The demand for these power plants is driven by the fact that they are replacing carbon-fired power plants which fell from 45% in 2010 to 22% in 2021 in the US and are poised to fall further. The demand for these power plants is increased by the reduction in the price of natural gas and vice versa. Since 2010 the price of natural gas in the US has fallen due to increased horizontal drilling and hydraulic fracturing. Given the energy outlook, we expect that the natural gas will be an important source of energy bridging the gap between fossil fuels and the rising power production from renewable sources in the future and serving as an acceptable complement to the renewable energy sources today. The price of natural gas is expected to remain relatively low in comparison to oil, however, sanctions on Russia have made it less economical, in some cases making spot purchases very unprofitable for owners of the CCGT assets.

New gas power plants will burn natural gas together with green hydrogen, with a possibility to switch to green hydrogen only. In the future, they will serve as a complement when the sun is not shining and the wind is not blowing to power wind farms and photovoltaic parks. Additionally, the gas power plants will serve as a backup in case of an emergency increase in loads and will be a sink for hydrogen which itself can be produced at times where wind speeds or sun strength is high but demand from the grid is low, allowing for effective battery-esque storage of energy to increase asset capacity factors, something that really brings down renewable assets’ attractiveness. With expertise to construct gas-fired plants that are capable of taking on the hydrogen opportunity, Argan isn’t being displaced by the renewable energy transition, also involving itself in explicit exposures like solar energy projects.

Conclusions

The backlog covers less than a year of normalized sales, and as the company liquidates this backlog order intake shouldn’t collapse to the extent that forecasts can’t be upheld. Revenues are expected to grow in the mid-single digits into the FY 2022, and the only concern is supply chain issues that have caused about 20% declines in revenues YoY for the Q1. These issues have been focused on the renewable business, specifically issues in acquiring photovoltaic cells, that have slowed down activity and billing rates in some important projects. The company trades at about 9.5x forward EBITDA versus 10.5x of some of Argan’s larger peers like Quanta (PWR). The markets are somewhat different with Quanta also dealing with onshore oil installations, which are actually probably among the most controversial fossil fuel operations possible in the US, and therefore the discount given to AGX’s multiple appears unreasonable. Revenue is being impacted by less robust vendor relationships, but the more focused exposure to renewable projects makes it deserve at least the same multiple. Nonetheless, the absolute case is what keeps us on the sidelines, with raising rates likely to retreat CAPEX cycles, especially for assets that use as inputs a commodity that is becoming comparatively more expensive. However, risk of impairment also seems limited due to an existing renewable angle on the business.

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