ARQ
INITIATION OF COVERAGE REPORT
ENERGY TRANSITION & SUSTAINABLE INVESTING
Arq, Inc.
October 7, 2024
ARQ: Significant EBITDA Growth from Execution and
Graham Mattison
graham.mattison@watertowerresearch.com
Expansion into Faster-Growth Markets
727-300-4702
KEY POINTS
KEY STATISTICS
Ticker:ExchangeARQ:NASDAQ
Current Price
$5.71
52-Week Range
$1.60-$8.26
Average Volume (30-Day)
285,644
Shares Outstanding (MM)
41.3
Market Cap ($MM)
$235.7
Enterprise Value ($MM)
$237.0
Fiscal Year-End
December
ESTIMATES
EPS
2023A
2024E
2025E
2026E
2027E
1Q
($0.32)A
($0.09)A
2Q
($0.21)A
($0.06)A
3Q
($0.07)A
$0.02E
4Q
$0.10A
($0.02)E
FY
($0.42)A
($0.15)E $0.00E
$0.20E
$0.61E
EBITDA ($MM)
2023A
2024E
2025E
2026E
2027E
1Q
($7.7)A
($1.1)A
2Q
($3.0)A
$0.5A
3Q
$0.9A
$3.3E
4Q
$7.2A
$1.9E
FY
($2.6)A
$4.6E
$11.1E
$20.1E
$38.7E
Revenue ($MM)
2023A
2024E
2025E
2026E
2027E
1Q
$20.8A
$21.7A
2Q
$20.4A
$25.4A
3Q
$29.8A
$30.2E
4Q
$28.1A
$28.7E
FY
$99.2A
$106.1E
$131.4E
$157.5E
$187.5E
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INITIATION OF COVERAGE REPORT
ENERGY TRANSITION & SUSTAINABLE INVESTING
COMPANY OVERVIEW
Arq, Inc. is a diversified environmental technology company focused on developing and providing solutions for air, water, and soil purification. The company is a leading producer of activated carbon (AC) (~23% of North American market share), which is used for contaminant removal in various applications, including mercury removal from power plants, water purification, specialty gas cleaning, and soil and groundwater remediation. Formerly known as Advanced Emissions Solutions (ADES), Arq and its predecessor companies have been at the forefront of providing cutting-edge products to control mercury and other contaminants for power generation and industrial companies since 1997. The January 2024 rebranding to Arq reflects a new focus on growth following the appointment of Bob Rasmus as CEO, the transformational acquisition of UK-based Arq, and the strategic expansion into the faster-growing GAC markets.
Arq is currently a leading supplier of PAC that it produces using lignite at its Red River plant in Louisiana, which has been in operation since 2011. The primary end market for PAC has been mercury control for coal-fired power plants, but the company has been increasing its presence in the water market as well. In October 2023, Arq began the expansion of the Red River site to add an incremental 25 million pounds of GAC capacity to meet the growing market demand from water, soil/groundwater remediation, gas purification, and PFAS. Initial GAC production is on track for 1Q25, and the company already has contracts for 52% of GAC nameplate capacity under construction.
Today, Arq is a vertically integrated AC producer working to provide innovative environmental solutions for a cleaner future. The company is focused on improving its foundational and cash-generating PAC business through execution and better contracting terms, while using it as a springboard into the higher-growth and more profitable GAC market.
Key Considerations
Expansion into the higher-margin and higher-growth GAC market well underway. Arq is in the late stages of building out incremental GAC production that we expect to drive higher margins than its PAC business as well as significant growth tailwinds from groundwater remediation, specialty gas purification (such as renewable natural gas/biomethane), and addressing PFAS.
The foundational PAC business provides a stable and cash flow positive platform to support the higher- margin and growth GAC business. By focusing on efficiency, customer diversification, and eliminating negative margin contracts (which were 24% of sales in 2023 but none in 2025), the PAC business has been transformed over the past 18 months and is now generating positive cash flow. In addition to its cash flow contributions, the PAC business helps support the entry into the GAC market through economies of scale, existing infrastructure, manufacturing processes, and industry relationships.
Impressive turnaround in the past 12 months; there is more room to run. In the past five quarters, the new team has significantly increased gross margin to the upper-30%range from the low-20%range, as well as reduced operating expenses, integrated the Arq acquisition, and positioned the company to expand into faster-growingmarkets. Management remains focused on execution, operating efficiency, and cost controls, which along with better pricing as older contracts roll off, should drive further margin expansion. This should be amplified as the higher- margin GAC business contributions start to ramp in 2025.
Forecast EBITDA ramp highlights improved profitability of GAC and the operating leveraging in the business model. We expect Arq to generate EBITDA of $69.6 million in 2028, up from ($2.6) million in 2023 and our estimate of $4.6 million in 2024. The growth in EBITDA is driven by contributions from the new GAC capacity, improved performance of the PAC business, and an ongoing focus on efficiency and cost controls.
Already permitted expansion plans give the option to add incremental GAC capacity quickly as demand accelerates. The 25 million pound per year GAC production line under development at Red River is the first of five modular GAC production lines that are fully permitted and could be built in response further demand growth, which would increase the company's nameplate GAC capacity to ~125 million pounds per year. The Corbin facility has ample feedstock to support further growth, and we expect that the next 25 million pounds of new capacity could be online within 18 months. The company see itself as having a two- to three-yearhead start on any competitor's potential expansion, which would have to secure feedstock and get through a permitting process that should take at least two years or more before construction could begin. A greenfield expansion would likely take even longer as the land and feedstock would have to be secured and the permitting and financing for a new build new "carbon" plant would be very challenging in today's environment (despite the fact that the carbon would be used to reduce pollution).
The concentration of AC producers should support market discipline around supply and pricing. Today, the North American market has consolidated to three main producers of AC, of which Arq represents about ~23%. The market is very competitive, however, we expect the market players to be very disciplined about bringing on new capacity given the periods of oversupply/low pricing the market has seem in the past years. While we do expect to
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see existing players add some capacity as demand increases, the incumbents should benefit more from higher pricing rather than incremental capacity that could depress pricing for years to come. It is highly unlikely that a new player would enter the market given the permitting hurdles, raw material supply and location challenges, and the cost of greenfield construction. We note that the last significant additional domestic greenfield AC capacity was in 2008 in anticipation of emissions control demands for coal-fired powerplants (that failed to fully materialize), and the new capacity was only made possible through the support and long-term supply contracts from a major Texas utility who has since gone bankrupt.
CEO is aligned with shareholders. Bob Rasmus, who was appointed CEO in 2023, negotiated to receive a cash salary of just $50,000 per year, with the rest of his compensation in equity. He also purchased ~1 million shares upon joining the company, purchased an additional ~25,000 shares as part of the September equity raise, and currently owns about 2.5% of the shares outstanding. Management and the Board of Directors collectively own about own about 20% of the company.
Recent GAC contract wins further mitigate expansion risks. Fifty-twopercent of the new capacity has already been contracted (more than six months ahead of production) with multiple companies in different end markets. The contracts support the market's confidence in the company's product quality as GAC is not fungible. It is a technical sale and the product must meet the customer's stringent specifications. Arq has stated that it is very confident that 100% of capacity will be fully contracted when production begins in 1Q25.
Vertical integration provides control over input cost and supply and also enhances margins. Arq is the only vertically integrated domestic supplier with direct control of its raw material supply for the production of PAC and GAC. The ownership of the supply chain provides both supply certainty and gives flexibility around raw materials. Further, this is a differentiating factor that can help drive better margins and provide a competitive advantage by qualifying Arq for benefits from the federal Build America, Buy America Act, and other state and local programs.
Growth potential from newer products beyond PAC and GAC. Arq has been developing additional products and applications that could add to EBITDA within three to five years (we do not have any contributions from the new products in our model). These include a new CCP platform that can be used at contaminated soil and groundwater remediation treatment sites and Arq powder, which is a lower-carbonfootprint additive component for asphalt.
Low-carbon footprint through the use of coal waste as a feedstock for GAC. Arq uses a patented process that transforms bituminous coal waste (also called fines) into Arq powder that is used as the feedstock for producing GAC. In addition to the cost and supply benefits, the Arq process has significant environmental benefits versus mining virgin coal for a feedstock, including potentially lower Scope 1 and 2 CO2 emissions by 40%. This is a potentially significant competitive advantage as GAC users (particularly municipalities and utilities) look to reduce their carbon footprint throughout their supply chain.
November election outcomes unlikely to have any near-term material impact on the business. Demand for Arq's products is driven primarily by consumer demand and existing regulations. We do not see either candidate's proposed policies as having a material impact on the AC market and the initial PFAS regulations were enacted during the previous Trump administration. Further, market moves following an election are typically short-livedand often run counter to prevailing narratives advanced by the new administration. For example, the Biden administration was widely seen as bad for the energy stocks (canceling the Keystone Pipeline, Green New Deal, etc.), yet energy has been one of the best, if not the best, performing market sectors during the Biden administration.
We do not see a near- or medium-term risk to AC demand from coal-fired power generation in the US. While coal-firedpower has declined precipitously since 2009 (both in absolute tons burned and as a percentage of the grid) due to low natural gas prices and regulations, coal is still ~16% of the US power grid and coal used in the power space has seen some slight growth in recent years. As demand for AI datacenters and electric vehicles (EVs) grows, the need for reliable baseload power should grow.
Increases in natural gas prices could provide an unexpected tailwind. Lower natural gas prices have negatively affected Arq's PAC sales in recent quarters as current low gas pricing helps the competitive position of gas-firedpower versus coal. Year to date, natural gas prices have averaged $2.10/MMbtu, well below the average of $4.37/MMbtu from 2010-2020and $4.31/MMbtu from 2000-2010.Should natural gas prices increase in the coming years, we expect to see more demand from the lower-pricedbaseload coal plants.
Upcoming Catalysts
The announcement of additional GAC contracts. In August, Arq announced it had contracted 52% of the new line's capacity with multiple contracts with companies in different end markets and it remains highly confident that it will have 100% of capacity contracted by 1Q25. Further capacity commitments should boost confidence in demand for GAC, earnings potential, and the potential to support demand for additional capacity.
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3Q24 earnings announcement. We expect the company to post another solid quarter when it reports in early November, which should show further margin growth from pricing, operating efficiencies, and contract management. We also expect to hear updates on the new GAC capacity, contracting status, and remaining capital spend.
Recent Events
Raises ~$29 million through equity issuance. On September 20, the company sold ~5.5 million shares (including the greenshoe) at $5.25 a share in a public market equity issuance. The funds will support the buildout of the GAC expansion at Red River and also greatly expand the company's options for negotiating new debt financings to replace the $10 million CFG loan that is both high cost and restrictive in terms of covenants and assets pledges.
Brings construction and project management of GAC expansion in-house.On September 17, the company terminated its agreements with contractor Wieland-Davcoafter determining that certain timing and budget efficiencies could be achieved by conducting construction and project management functions internally. There is no change to the timeline or cost of commissioning and first production, and we expect that this move will give the company better control over the project and positions it to be ready to begin work on the potential next phases of GAC production.
Strong 2Q24 results. On August 12, Arq reported Y/Y revenue growth of 24%, a 16% increase in average selling price (fifth consecutive quarterly increase), and positive adjusted EBITDA of $0.5 million versus negative $3 million in 2Q23. The quarter also showed continued execution toward the company's stated targets and progress on the GAC growth projects.
New GAC contracts for the Red River expansion. In August, Arq announced it had signed supply contracts for 52% of nameplate capacity of its GAC expansion at its Red River facility. The contracts are with multiple companies who will be using the GAC in a variety of end markets, helping to diversify the company's customer base and its end market concentration.
EPA announces new PFAS rule. In April 2024, the EPA issued the first national drinking water standard to address PFAS. It is estimated that one-third of the public water systems will require PFAS treatment facilities, which should drive a significant increase in the demand for GAC.
ARQ added to the Russell Index. On July 1, 2024, the company was added to the added to the broad-market Russell 3000® Index and the Russell 2000® Index.
COMPANY DESCRIPTION
Arq is a diversified environmental technology company focused on developing and providing solutions for air, water, and soil purification. The company is a leading producer of AC (~23% share of the North American market) that is used for contaminant removal in various applications, including mercury removal from power plants, water purification, specialty gas cleaning, and soil and groundwater remediation.
Formerly known as Advanced Emissions Solutions (NASDAQ:ADES), the company has been at the forefront of providing cutting-edge products to control mercury and other contaminants for power generation and industrial companies since 1997.
In February 2023, ADES acquired 100% of the equity of the subsidiaries of Arq Limited, a UK-based environmental technology company founded in 2015 that developed a novel process for producing specialty carbon products from coal mining waste. The acquisition of Arq's technology and its Corbin Kentucky processing facility gave the company an entry into the faster-growing GAC market through its high-quality feedstock that has lower operating costs and reduced environmental footprint versus conventional producers.
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Figure 1: Arq Acquisition Overview
Source: Company reports, Water Tower Research
The January 2024 rebranding to Arq reflects a new focus on growth following the appointment of Bob Rasmus as CEO, the transformational acquisition of UK-based Arq, and the strategic expansion into the GAC markets.
Company Operations
Today, Arq has its corporate headquarters and R&D facilities in Denver (Greenwood Village, CO), its Red River AC plant in Coushatta, Louisiana, along with long-term leases for the plant's lignite feedstock, and its facility in Corbin, Kentucky, which produces bituminous coal waste feedstock for GAC production at Red River.
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Figure 2: Arq Facilities
Source: Company reports, Water Tower Research
Red River
The Red River facility is the site of the company's flagship AC manufacturing facility in Coushatta, Louisiana. The purpose-built facility, which was brought online in 2010, was originally designed for annual PAC production capacity of 125-150 million pounds, with the potential to double its annual output to meet the expected ramp in demand for mercury control at coal-fired power plants from the federal Clean Air Mercury Rule (CAMR), which later became the Mercury and Air Toxics Standards (MATS). In 2007, the company stated that the capital cost for the initial production line would be about $260 million.
The AC plant is supplied by a nearby lignite mine that the company controls through ownership and long-term leases for mineral rights and right-of-use purposes that expire at varying dates over the next 30 years and contain options to renew.
The actual production capacity at Red River was never made public when the plant was owned by a private company. Since its 2018 acquisition, the capacity has not been released for competitive reasons, however, it is reported that the Red River plant has an annual PAC output of about 100 million pounds per year.
Following the Arq merger, the company embarked upon an expansion at the Red River plant to allow for the incremental production of GAC using waste feedstock from its Corbin, Kentucky facility. The expansion plan has five potential phases, all of which are permitted and have the support of the State of Louisiana though incentives and tax breaks.
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Construction of the initial phase began in late fall 2023 and, through design enhancements, will add 25 million pounds per year of GAC capacity that will be incremental to the existing PAC capacity at the plant. Total cost of the expansion project (which includes upgrades at Corbin) is expected to be $60-70 million in 2024. The upgrades at Corbin were commissioned in 2Q24 and the company expects the new line at Red River to be commissioned from Q424 with first product deliveries in 1Q25.
Figure 3: Red River AC Plant
Source: Company reports, Water Tower Research
Corbin
The Corbin facility uses a patented manufacturing process to convert bituminous coal waste (also called fines) into carbon powder known as Arq powder that is used as the feedstock for GAC produced at Red River. The facility, which is located at a dormant US Steel coal preparation site (also called coal washing station), was built for ~$80 million in 2019. In addition to creating the feedstock for the GAC production, the company is developing the Arq powder for other markets, including its use as a lower-carbon footprint additive component for asphalt.
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Figure 4: Corbin, Kentucky Facility
Source: Company reports, Water Tower Research
Activated Carbon (AC) Overview
AC (also called activated charcoal or activated coal) is a specialized sorbent material that is used to remove impurities, contaminants, and pollutants in a wide range of industries such as water purification, power plant emissions control, industrial gas purification, and soil remediation. When the carbon is "activated" (either through a heat treatment or chemical treatment), its surface area is massively expanded, resulting in a highly porous substance that can adsorb and remove organic compounds from liquids and gases. In adsorption, organic molecules contained in a liquid or gas are attracted and bound to the surface of the pores of the AC, while the liquid or gas is passed through. Adsorption (where items adhere) is different from absorption (items are taken in).
Figure 5: Adsorption vs. Absorption
Source: Kuraray, Water Tower Research
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The activation process can be thought of like making popcorn: when the kernel is exposed to high heat, it transforms into a fluffy and light material with a much higher surface to volume ratio.
Figure 6: Activation Process
Source: Royal Society of Chemistry, Water Tower Research
Raw Materials
AC may be made from any carbonaceous material such as bamboo, coconut husk, willow peat, wood, lignite, coal, and petroleum pitch, however not all raw materials cannot be made into the same quality of AC. Different raw materials are used in different end markets based on price and availability, but more importantly iodine ratios, ash content, and particle size distribution. Bituminous coal is typically the highest-quality raw material, but sub-bituminous or lignite coal can be more effective in certain applications (such as air pollution control) due to its pore structures.
Figure 7: Typical Raw Materials for AC
Source: Kuraray, Water Tower Research
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AC can be categorized into different classes based on its physical appearance. The main categories are:
Powdered Activated Carbon (PAC): PAC is the most common form of AC and is produced by grinding raw carbonaceous materials such as coal, wood, or coconut shells into fine particles.
Granular Activated Carbon (GAC): GAC consists of larger granules with more extended contact time and better flow characteristics compared with PAC. GAC, which can only be made from materials that are high in carbon, such as coal, coconut shells, peat and wood, is utilized in both liquid- and gas-phase applications, such as groundwater remediation, air purification, and gas purification in industrial processes.
Colloidal activated carbon (CAC or CCP): CAC a specialized form of AC, with particles milled to less than 2 microns in size and suspended in a liquid and then used in situ (in place) to remove contaminants from groundwater.
Market Uses and Demand
AC is used in a wide range of applications, including industrial demand, water filtration, wastewater, medical, air pollution control, and the food and beverage industry. Typical consumers might encounter activated carbon inside of the water filter for drinking water or a fish tank or in their N-95 masks. The industry has typically grown in line with GDP but has seen periods of faster growth due to regulations, such as the mandates to remove mercury emissions from coal-fired power plants. Key markets for Arq include the following.
Mercury Emission Control from Coal-Fired Power Plants
Arq's predecessor companies were at the forefront of developing the technology to remove mercury emissions from coal-fired power plants and the company has multiple patents around the process. PAC, because of its pore structures, is a well-established and cost-effective solution for mercury control. The PAC is slowly fed into the flue gas post combustion where the mercury is adsorbed by the AC, which is then captured in the fabric filters (used to collect particulate matter as part of the overall emissions control train). Demand for mercury control has been driven by federal and state regulations as well as individual consent decrees made by specific plants.
US coal-fired power has declined precipitously over the past 15 years due to a combination of environmental regulations, growth in renewable power such as wind and solar, and the impact of the fracking revolution that has driven a 75% drop in natural gas prices since 2008. Today, natural gas generates about 43% of US electricity, up from ~20% of US electric power generation in 2010, while coal has declined to ~16% of US generation. However, coal used to generate electricity has actually seen a slight rebound in recent years due to natural gas price volatility and increased need for baseload electric power to support new datacenters (AI and Bitcoin) as well as power to charge the growing fleet of EVs.
Figure 8: Coal Used for Power Generation
Source: EIA, Water Tower Research
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Disclaimer
Arq Inc. published this content on October 07, 2024, and is solely responsible for the information contained herein. Distributed by Public, unedited and unaltered, on October 09, 2024 at 15:51:02.173.