MagicDiligence
Magic Recipe -3.12%
Deep Value -4.18%
Star List -2.34%
S&P -1.74%
Today's Performance

Argan, Inc.


$39.16
$590.0 Million
16.5%
2.6%
1127.8%
150.7%
149.0%
19.9%
19.3%
1.84
Logo

Instant Diligence

You need a MagicDiligence Membership to see the Instant Diligence for this stock. If you are already a member, you need to log in first!

Stock Review

Today we'll go slightly off script.

Usually, I write from time-to-time about interesting stocks in our Magic Recipe Spell or one of the other subscriber Spells.

However, using the Spell Caster tool, I wanted to look at some smaller stocks.

Using the Magic Recipe as a template, and lowering the market cap minimum to $500 million, some interesting additional options popped up.

There was one in particular that has looked interesting for quite a while, and today looks as intriguing as ever to me. Let's take a look.

A Remarkable Transformation in U.S. Energy

A pretty remarkable transformation is taking place in how electricity in the U.S. is generated.

Historically, the largest source of energy (by far) in the country has been coal. As recently as 2008, coal accounted for about half of all electrical generation.

This was perfectly logical. The United States has long been the "Saudi Arabia of coal", with almost 27% of the world's reserves in the Appalachian Mountains, Midwest, and the Powder River Basin of Wyoming. Coal was cheap, plentiful, and domestic - the last being of prime importance over the last 4 decades, considering the country relied on the volatile Middle East for much of its oil supply.

But over the past 3 years, this is changing. And the nature of that change is set to benefit the stock I'm highlighting today: Argan (AGX).

Coal Is Out

Since 2012, the Environmental Protection Agency ("EPA") and the federal government have undertaken what some have called a "war on coal".

Coal Sludge

Coal is the single biggest air polluter in the U.S.. Burning it creates toxic sludge, which include arsenic, mercury, and other harmful chemicals. Burning coal creates a large discharge of carbon dioxide and sulfur dioxide into the air, creating smog and acid rain. Mercury is particularly harmful - a highly toxic heavy metal that can easily pollute the fish supply in lakes. Coal burning creates half of human-generated mercury emissions.

In light of this, last August President Obama unveiled new regulations, the first ever federal limits on carbon emissions from power plants. This comes on the back of new coal ash rules in December of 2014, and the 2012 Mercury and Air Toxic Standards laws (which was overturned by the Supreme Court last year).

Put simply, the government is clearly trying to move the country away from its largest source of electrical power. And I don't expect this to change any time soon.

Natural Gas Is In

As recently as 2008, coal generated almost 50% of this country's electricity - far and away the dominant source of energy. So how to we replace it?

One attractive solution has emerged over the last 5 years - natural gas.

As it turns out, the United States, through hydraulic fracturing (or "fracking") techniques, is also the "Saudi Arabia of natural gas"! The country produces 20% of the world's supply and has grown production by over 21% since 2010. As a result of this abundance, natural gas prices have plummeted from over $12 in early 2008 to about $2 today.

Natural Gas

As it turns out, natural gas makes a pretty good boiler fuel to generate electricity with. It has roughly the same thermal efficiency as coal. However, it is much cleaner, producing only about half the carbon dioxide of coal. It produces very little solid wastes (unlike coal).

As a result, swapping out coal boilers with nat gas fired ones has been a more economic alternative for energy companies than trying to comply with expensive coal emissions regulations. Since 2005, coal has dropped from 50% of U.S. electricity to 38%... nat gas has risen to 28% from 15% in the same time period. In the next 8 years, more than 28,000 MW of coal power is scheduled to be taken out of commission. The future for U.S. energy is natural gas and wind (and to a lesser extent, solar). Coal is clearly being phased out.

Where Argan Fits In

It is quite simple to see why this should benefit Argan.

Argan's business is constructing natural gas fired and alternative energy power plants, through its subsidiary Gemma Power Systems (GPS). Its two big current projects over the past few years, Panda Liberty and Panda Patriot, are large nat gas plants being built in Pennsylvania, jointly accounting for 86% of revenue. Other past projects include the completed Sentinel nat gas project in California, wind power farms in Illinois and Pennsylvania, and plant powered by wood chips in Texas!

Power Sources in U.S.

Clearly, Argan's specialty plays right into this theme of transitioning power supply in the United States. There should be no shortage of opportunities for retrofitting coal plants or building new nat gas or wind farms in the U.S. for the foreseeable future.

While the Panda projects - both 800MW nat gas plants - are wrapping up, Argan has seen a flurry of new jobs to replace them. Two 475MW projects with NTE, a 785MW plant with Competitive Power in Connecticut, and a large 1,000MW plant with Moxie in Pennsylvania have all received full notices to proceed. All together, that's over 2,700MW in work coming on line to replace two jobs totalling 1,600MW. While revenue probably will not scale exactly, we can see Argan is clearly not only replacing work, but greatly expanding it. This sets the company up to perform nicely for at least the next few years (all projects here are slated to wrap up in 2018).

And that's not to mention the firm's foray internationally. Last May, Argan purchased Atlantic Projects to gain exposure to international demand for power plant projects. This is attractive, as unlike the U.S., emerging economy electricity demand is expected to grow over 30% between now and 2035, driven by China, India, and the Middle East. Argan should be able to get a piece of that action now, as well.

Argan has a 5-year compound revenue growth rate over 18%, and I see plenty of opportunity to continue that kind of growth for many years.

Risky Stock

Prospective buyers should be aware that Argan is a risky investment.

Even with the new jobs, this is a company relying on basically 4 projects for their entire business. Any major issues with any one of them would be very detrimental to overall results, as could cost overruns or project delays. Over time, the company will need to continue to win business, and remember that Argan is a small fry that competes with some very large engineering firms like Fluor (FLR) and Chicago Bridge & Iron (CBI). Competition is intense.

The final risk I should point out is the other side of the political coin - the potential for gas fracking bans. Several states including New York and New Jersey have banned the process that generates so much natural gas in the U.S., and more evidence of fracking being harmful could lead to more bans or regulations that slow down the adoption of nat gas as a power source. In this case, Argan could see its potential workload dwindle and the stock would be hurt.

Wrap Up

Argan is an attractive, well-managed, small engineering firm that is nicely positioned into a long-term domestic trend, with exposure to still growing international business. One great thing is that the firm is so small that it only takes a few additional contract wins to continue growing the business at this point. While there is reasonable concern and uncertainty about its limited project exposure, Argan has a good track record of completing, replacing, and ultimately growing their project scope over the longer term. It looks like an interesting play on the longer term energy trend in the U.S.

Company Description

Argan, Inc. provides consulting, engineering, procurement, construction, commissioning, operations and maintenance services to the power generation and renewable energy. The company provides services to the telecommunication, public utilities, power, municipalities, and public and private industries. The company operates through its subsidiaries: Gemma Power Systems LLC and Southern Maryland Cable, Inc. The Gemma Power Systems is a power plant designer and builder with expertise in engineering, design, procurement and construction. The company excels in developing traditional natural gas power plants as well as alternative fuel projects, including biodiesel, ethanol, and other renewable energy sources such as biomass, wind and solar. The Southern Maryland Cable provides comprehensive technology wiring and utility construction solutions. The company furnishes inside premise wiring services to the federal government, including military installations and government office sites requiring high-level security clearance, and underground and aerial construction services and splicing to utility, telecommunications, construction and local government customers. The company was founded in May 1961 and is headquartered in Rockville, MD.

Calculations

You need a MagicDiligence Membership to see the Calculations for this stock. If you are already a member, you need to log in first!

Joel Greenblatt and MagicFormulaInvesting.com are not associated in any way with this website. Neither Mr. Greenblatt or MagicFormulaInvesting.com endorse this website's investment opinions, strategy, or products. Investment recommendations on this website are not chosen by Mr. Greenblatt, nor are they based on Mr. Greenblatt's proprietary investment model, and are not chosen by MagicFormulaInvesting.com. Magic Formula® is a registered trademark of MagicFormulaInvesting.com, which has no connection to this website. The information on this website is for informational purposes only and solely represents the views and opinions of the author. No warranty is provided or implied as to the accuracy, completeness, or timeliness of this information. This information may not be construed as investment advice of any kind, nor can it be relied upon as the basis for stock trades. DON'T RELY SOLELY ON THIS WEBSITE'S INFORMATION OR STATISTICS! Please do your own research before buying. Alexander Online Properties LLC, the proprietor of this website, is not responsible in any way for losses or damages resulting from the use of this information. Alexander Online Properties LLC is not a registered investment advisor. All logos are trademarked properties of their respective companies.

© 2008-2016 Alexander Online Properties LLC