Earnings Yield: 54%
Return On Capital: 21%
Argan (NYSE:AGX) has been in and out of the magic formula screen for quite some time now and it finally re-appeared on the Top 30/50 million screen this past weekend. Argan is a holding company which conducts operations through its wholly owned subsidiaries, Gemma Power Systems (GPS) and Southern Maryland Cable, Inc. (SMC).
At first glance, the company appears to be undervalued as it has many of the characteristics value investors look for in a company. For one, Argan has $175 million in cash, no long term debt and a market cap of just under $200 million. Not too mention, the company is generating pre-tax income of $17 million. Looks good right? Not exactly. Argan takes on rather large infrastructure and engineering projects and is paid upfront for these projects. Sooner or later it is going to need that excess cash to complete the projects.
Argan is also facing some major economic headwinds as construction spending and electricity consumption per capita remain well off 2007 peak levels. The latter is a serious concern for the company as power plant operators are less reluctant to build new power plants when the current demand for power is weak. The former is something all engineering & construction firms have been grappling with for the past 5 years and will likely continue in the foreseeable future. Which brings me to my next point. Construction and Engineering has long been a low margin business. In this type of environment, it is taken to the next level as companies are willing to sacrifice profitability to win a bid. At the same time, you have companies from other sectors competing for construction jobs. For example, U.S. Defense contractor SAIC (SAI), has been building and growing its energy and environmental business.
As such, i'm not interested in Argan (NYSE:AGX). The magic formula numbers look compelling, but looking under the hood, it might burn through the cash and I don't see any meaningful growth occurring anytime soon. If economic conditions continue to deteriorate, it will only prolong Argan's ability to experience real growth.
Disclaimer: No plans to go long or short Argan (NYSE:AGX), I presently own shares of SAIC (SAI)