Micro Cap’s Pivot to Automation & Profitability Starting To Get Noticed By Wall Street

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Thursday, May 21, 2020

Many businesses pivot to keep pace with the times. Amazon.com (NASDAQ:AMZN) was once only an online bookstore before ultimately revolutionizing online shopping. Netflix (NASDAQ:NFLX) began as a DVD delivery service. And decades ago, Microsoft (NASDAQ:MSFT) was nearly entirely hardware and BlackBerry (NYSE:BB) (TSX:BB) was king of commercial smartphones.

Who knows where any of these companies would be today had management not had the vision to change direction?

In 2018, ENGlobal (NASDAQ:ENG) decided it was time to pivot away from low-margin, manpower-intensive jobs as an engineering consulting firm, and move into offering turnkey modular process and automation systems primarily to the global energy sector. The plan was to correct declining revenue and net losses by providing these much-needed, higher-margin solutions -- while leaning to a much lesser degree on its lower-margin engineering consulting and technical staffing unit.

Less than two years later, led by this strategic pivot, ENGlobal is posting impressive numbers. In Q1 2020 – against the backdrop of the coronavirus pandemic and oil prices being at multi-year lows – ENGlobal reported a 58% increase in revenue to $19.3 million and a second straight profitable quarter for the first time in five years.

Net income for the quarter came in at $1.1 million, or $.04 per share, reversing from a net loss of $974,000, or ($0.04) per share, in Q1 2019.

ENG CEO Bill Coskey and CFO Mark Hess weren’t shy in the quarterly earnings call to note that business was hamstrung to a degree by the COVID-19 crisis. Some new projects were delayed, and one contract was cancelled because of the pandemic, they said.

The profits were the result of several factors, including the higher revenue, tighter cost controls and improved margins. The bulk of the revenue (73%) came from the automation business, which generated gross profit margin of 21%. That helped elevate aggregate gross margin to 17% for the quarter from 10% a year earlier and closer to management’s 20% target.

During the March quarter, ENGlobal benefited from a new collaboration with Haldor Topsoe, in which ENG is supplying process modules being used to construct a complete hydrogen production facility. The contract is expected to generate at least $25 million in revenue for ENGlobal over the next twelve months.

A contract is one thing, but the growing relationships ENGlobal is building with process technology firms and OEMs have many implications for potential future work. The Haldor Topsoe technology, for example, has been proven across more than 40 international installations to greatly increase efficiency in the facility while reducing its carbon footprint compared to traditional technology. Its application extends beyond the traditional oil and gas industry - for the production of renewable fuels, methanol, and ammonia used in fertilizers.   However, this is the first time this green technology is being utilized in the U.S., where industry is clamoring for green innovation and reduced expenses.

Seeking Alpha author Sergio Heiber pegged the turning point and catalysts for ENG last year and continues to see substantial upside given that the company is delivering and the stock price hasn’t responded accordingly yet.

Per Heiber’s latest article, there are very limited comparables to ENG because the company is actually profitable, when nearly all peers are not. To that end, using the standard price-to-earnings ratio is not possible.

Instead, he uses a price-to-sales analysis while accounting for the fact that ENG isn’t a pure renewable energy play. Keeping a very conservative target of P/S ratio of 1.0 versus 2.53 from the peer group, Heiber sees an upside of at least 2x from the current price per share around $1.00.

With ENGlobal holding $59 million in backlogged work, $6.8 million in cash and $11.9 million in working capital, Heiber makes a strong case for why his analysis is both accurate and modest at the same time.

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