Inside this small holding company is an extremely profitable power-plant builder. By Bob Frick, Senior Editor March 4, 2008 The world's insatiable demand for oil has led to a run-up in energy-related stocks, so you must dig deep for a cheap power play. But look deep down the well of small-company stocks, and inside a holding company named Argan (symbol AGX), you'll find a gem named Gemma Power Systems. Gemma designs and builds power plants, from traditional gas- and coal-fired plants to nouveau biofuel and wind systems. It recently landed a $340 million contract to build a natural-gas-fired plant for Pacific Gas & Electric. This is a big deal for an operation Gemma's size (Argan generated revenues of $195 million over the past year, and the stock's market value is $130 million). Before the PG&E deal, Gemma had a backlog of seven projects representing $166 million in revenues. If all goes according to schedule, those smaller projects will be finished by the end of next year, and the PG&E plant will be finished in the middle of 2010. Gemma is extremely profitable, but that may not be obvious at first glance. Argan holds three companies: In addition to Gemma, it owns Southern Maryland Cable, which does high-tech wiring for government and telecom companies, and Vitarich, which is a contract vitamin maker. Advertisement Together, Vitarich and Southern Maryland Cable account for just 15% of Argan's revenues, and they've accounted for write-offs and other financial noise that have mucked up Argan's financials. In Argan's third quarter, which ended October 31, the company lost $1.9 million; the quarter before that it made $1.3 million; the one before that it lost $2 million; the quarter before that it made $315,000 ... you get the picture. What's important to focus on is Gemma, which Argan bought in December 2006. Argan chief executive Rainer Bosselmann says Gemma will "conservatively" earn 7%, pre-tax, on its backlog. That means that half a billion in contracts is worth at least $35 million in income. Bosselmann clearly expects the company to make more. Robert Averick, a portfolio manager for Richard L. Scott Investments, which owns Argan stock, says the company has become adept at letting "non-economic contracts go by." He says Argan now wisely avoids fixed-price contracts and, instead, enters deals that require clients to pay for key materials. Thanks to Gemma, Argan shares look cheap. The company should generate earnings before interest, taxes, depreciation and amortization (EBITDA) of at least $20 million in the next year. So Argan trades at just a bit more than six times EBITDA. The typical power-plant construction company sells at about seven to eight times EBITDA. The stock closed at $11.70 on March 4, down 0.4%. Advertisement Gemma's prospects are bright. While growth in alternative-energy plants has stalled with the credit crisis, utilities are building traditional plants at a healthy clip. Gemma, in fact, focused on building alternative-energy plants before Argan bought it, Bosselmann says. He says Gemma will concentrate on traditional plants, which utilities pay for themselves, until financing frees up for alternative-energy facilities, which are often funded by private-equity investors. When that happens, "the opportunities for Gemma will be very interesting," he says. Argan's smallness is a two-edged sword for investors. It's so small that many investors haven't yet discovered it, so the shares are cheap. On the other hand, no analysts follow Argan, and that absence of attention doesn't help the stock price. Bosselmann says he'll spend "a little more time and money" on raising the company's profile this year. That may include changing its listing from the American Stock Exchange to the New York Stock Exchange. But by the time that happens, Gemma may have announced even more contracts and the bargain window for the stock may have slammed shut.