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Argan Inc. Might Be The Cheapest Dividend Stock in the Entire World
3x EV/EBIT ratio, anyone?
Everyone is obsessed with dividend payers that consistently grow their top and bottom lines, something that inevitably leads to dividend increases.
It’s easy to see why. Those are the kinds of stocks you can hold for decades, enjoying a dividend stream that more than keeps up with inflation growth. Millions of investors hold such stocks in retirement accounts for exactly that reason. It’s nice to have inflation protection when your expenses tend to go up over time.
There’s just one problem. Those kinds of stocks rarely go on sale. At best you’ll pay a fair price for them. At worst you’ll end up overpaying, which impacts the capital return part of the return profile. You’ll still end up with a rising dividend but the stock price itself won’t do much of anything.
This is partly why I embrace a dividend value perspective for a portion of my portfolio. A dirt-cheap stock that also pays a dividend offers better capital gains potential while still satisfying my thirst for yield. Yes, you could argue a stock that gets truly cheap is likely a crummier business than one that doesn’t, which is why this strategy only forms a portion of my portfolio. The majority of my money is tied up in excellent businesses, things like Canadian banks, telecoms, and pipeline giants.
The other thing is these cheap dividend payers are perfect candidates for a TFSA or RRSP. You’ll want to trade them, not hold them forever. You buy in, hold for a while, and then exit once the stock reaches some sort of intrinsic value. And if you’re wrong — and I sure am — at least you’re getting paid a dividend while you wait.
I think Argan (NYSE:AGX) is such a stock today. It’s not Canadian, but I still think it warrants a closer look. Let’s have a boo.
Argan, through various subsidiaries, builds natural gas-fired power plants for various clients around the world.
Like any construction company, this translates into lumpy returns. Projects come and projects go, with a stronger economy translating into more work in the pipeline. Investors don’t like to see lumpy. They like to see consistent.
And this graph (which illustrates revenue and earnings) is not an example of consistent.
This is the kind of business someone who has in a coma for a decade wouldn’t mind owning. Revenues and earnings essentially doubled over the last ten years. That’s not terrible! You just had to put up with a bunch of ups and downs in the interim. But it’s not something a normal investor would have the patience to own over multiple years.
One of the major risks of owning a construction stock is the risk of your engineers screwing up a project. This means Argan keeps a lot of cash on its balance sheet. As it stands today, the company has $319M in cash and short-term securities on its balance sheet and zero debt.
Its market cap today is $492M, and that’s after a nice move higher during Friday’s trading. The market is valuing Argan at just $173M net of cash.
Over the last twelve months, Argan has delivered just over $26M in earnings. This puts it at about 6.5x earnings, net cash.
I’m the first to admit the whole ex-cash universe gets a little murky. If a company has no plan for its cash and it just sits on the balance sheet forever, then all that cash has little use. Fortunately, Argan has been using some of its cash in an intelligent way.
It has been gobbling up shares furiously over the last year. Over the last six months it has spent $53M repurchasing 1.4 million shares. That works out to approximately 10% of total shares outstanding. Not bad for six months worth of buybacks. It has authorization to do $75M worth of buybacks for 2022.
The buyback is excellent news, quite frankly. Argan has had too much cash on its balance sheet for years now. This not only shows management is finally getting serious about returning cash to shareholders, it also opens the door to things like special dividends. A combination of both would be helpful to long-suffering shareholders who have witnessed the stock do nothing for the better part of a decade.
Argan also pays a $1 per share regular dividend, good enough for approximately a 3% yield today.
Argan has approximately $700M worth of projects in the pipeline, with the majority of that concentrated in the Gurensey project, a massive natural gas plant located in Ohio near the Pennsylvania gas fields. This 1800MW project is expected to be complete in 2023 and will generate enough electricity to power approximately a million homes.
There isn’t much besides Gurensey in the pipeline, but I’m not particularly worried. Spending on renewable projects will continue to be strong, and Argan has expanded into that segment. Natural gas generation is also a good bridge between coal-fired and renewable energy. Coal plants continue to shutter, especially considering the price of coal these days. Higher interest rates are likely giving utilities pause, but overall I see conditions looking pretty good for Argan’s pipeline.
A tepid overall economy changes this, of course. But then there’s also apparently a European energy crisis? I view the two as sort of cancelling each other out, which overall translates into a pretty good outlook.
The stock also tends to surge on the news whenever the company announces new projects.
The bottom line
Argan is not the kind of business I’d tuck away for a long time. It’s a trading stock for me. I’d sit on it and hope for a quick 25-50% gain over 6-12 months as the pipeline improves and management continues to execute on the stock buyback.
At 3x EV/EBIT, it certainly is cheap enough. Downside at this point is fairly limited. It’s just too cheap to really go much lower. And the cash cushion also helps to limit downside. It’s a $34 stock today. $20+ per share is in cash.
But at the same time, I’m not sure I’m super excited about this name. It has been this cheap for years now. I’m not sure the share buyback will be enough to make up for the lumpiness of the business. It’s an unsexy name without an obvious catalyst. If management held a large stake in the business (spoiler alert: they don’t), then this would be a good candidate to take private. But it’s not, which limits the upside.
Essentially, this bad boy is a value trap.
Disclosure: No position and no plans to initiate any.
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