Monday, July 2, 2012

Argan ( NYSE - AGX ) -- Powers Up

Argan (AGX $13.75) is a leading producer of next generation electricity power plants.  The company has a proven track record of bringing natural gas and a variety of green energy facilities on line, usually earning bonus payments for timely completion and on-budget performance.  Electricity demand is rising in the United States despite the poor economy.  Much of that is due to growing computerization, greater air conditioning use, and the proliferation of electronic appliances.  Argan's performance has fluctuated in recent years due to the ebb and flow of government subsidies, which have been instrumental in moving green energy projects to fruition.  The company was an early participant in natural gas facilities, though.  That segment has kept profitability intact despite the government ups and downs.  Utilities have been shuttering coal and nuclear sites, moving instead to that abundant low cost fuel.  A recent deal to build two plants right in the middle of fracking country promises to lift results substantially over the next two years.  Performance could continue to surge if the economy starts to recover, and solar power achieves grid parity as expected in 2015.  The ability to meet rising electricity demand with low cost and low greenhouse gas facilities promises to drive earnings sharply higher through the end of the decade.

The weak economy is holding back the industry's development.  Electricity demand is predicted to expand 2x the rate of GDP growth under normal circumstances.  Since 2008 demand has climbed but growth has been below the long term trend line.  New construction has been driven primarily by expiring subsidies and replacement needs.  Argan encounters stiff competition under the current scenario.  Many contractors underbid projects to keep their own teams working.  But they don't pay their subcontactors.  Argan has a great record.  But a major acceleration is unlikely until the industry's economics recover.

Backlog stood at $415 million as of January 31st.  That was reduced by first quarter (April) revenue of $57.7 million.  (Argan also operates a  non core subsidiary that generated sales of $6.0 million during the period.)  A natural gas facility in California accounted for $268 million of the backlog.  Most of the rest was related to a wood chip burning operation in Texas.  In the past Argan has installed a variety of wind, solar, and biomass systems.

Argan is working to get the necessary permits and approvals to build two major natural gas facilities in Pennylvania.  The company is helping to finance the operator ("Moxie"), which plans to set up shop next to a major natural gas field and sell the elctricity into the northeast grid.  Argan recently agreed to front more money (a total of $9 million) in exchange for greater operational controls.  The ultimate contract could be worth $750 million to $1.0 billion. 

The upcoming presidential election is creating uncertainty.  The Democrats oppose natural gas because its low price undercuts other green energy options.  The Republicans curry favor with coal and nuclear interests.  Either way, we believe the United States will go with the best price performance option.  Argan is well positioned to thrive as natural gas and solar become larger contributors to the electricity mix.  We also believe the economy is capable of booming over the next decade, forcing utilities to expand generating capacity immensely. 

In 2-3 years income could reach $2.50 a share.  Applying a P/E multiple of 12x suggests a target price of $30 a share, potential appreciation of 120% from the current quote.  If electricity shortages ever become a concern, a substantially higher valuation could emerge.

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