Granular Activated Carbon Setbacks Will Dominate Near Term Yet Long Term Demand Will Strengthen Prospects

Catalysts

About Arq

Arq produces powdered and granular activated carbon products and is developing new carbon based materials from waste derived feedstocks.

What are the underlying business or industry changes driving this perspective?

• Although demand for granular activated carbon in water treatment and environmental compliance is expanding, continued delays in resolving design flaws and achieving Red River nameplate capacity until around mid 2026 could defer the revenue step change needed to improve earnings.
• While the PAC turnaround and pricing power show that the legacy platform can more than cover maintenance capital, PAC growth is structurally modest and may not offset prolonged GAC underperformance, which may cap long term consolidated revenue and EBITDA expansion.
• Although regulatory and infrastructure driven needs for cleaner water and emissions control support robust long term activated carbon consumption, Arq's reliance on a single large GAC facility with technical bottlenecks raises the risk that fixed costs and margin drag persist longer than expected, which could pressure gross margin and net income.
• Despite multiple high potential applications for Arq Wetcake in asphalt, purified coal, rare earths and synthetic graphite, long development timelines, technical risk and dependence on government or partner funding could delay commercialization, limiting the contribution of these adjacencies to revenue diversification and margin uplift.
• While tighter domestic supply of activated carbon and strong pricing could support attractive unit economics once volumes scale, the need for an $8 million to $10 million thermal oxidizer and possible feedstock changes increases capital intensity and execution risk, which may constrain free cash flow and weigh on earnings if ramp milestones slip again.

Assumptions

This narrative explores a more pessimistic perspective on Arq compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Arq's revenue will grow by 11.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -3.3% today to 3.6% in 3 years time.
• The bearish analysts expect earnings to reach $5.8 million (and earnings per share of $0.14) by about December 2028, up from $-3.9 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $20.9 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 67.9x on those 2028 earnings, up from -36.5x today. This future PE is greater than the current PE for the US Chemicals industry at 24.0x.
• The bearish analysts expect the number of shares outstanding to grow by 1.62% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.8%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Prolonged underperformance and design related bottlenecks at the Red River granular activated carbon facility, including dependence on a new thermal oxidizer and experimentation with alternative feedstocks, could delay the move from suboptimal volumes to full nameplate capacity beyond mid 2026. This could limit the expected step change in granular activated carbon revenue and keep consolidated earnings under pressure.
• High fixed costs, elevated ramp up inefficiencies and the need for an estimated $8 million to $10 million in additional capital for the purpose built thermal oxidizer may keep gross margins depressed for several more quarters while cash balances decline from current levels. This could potentially constrain free cash flow and delay a sustained improvement in net income.
• If long term market tightness in granular activated carbon eases faster than expected due to new competing capacity or slower regulatory driven demand growth, Arq may not fully monetize the current pricing power implied by today’s supply constrained conditions. This would cap future gross margin expansion and EBITDA growth.
• The strategy to create new high growth adjacencies from Arq Wetcake in asphalt, purified coal, rare earths and synthetic graphite depends heavily on long development cycles and government or partner funding. Slower than expected commercialization of these projects could limit diversification of revenue and delay any meaningful uplift in net margins.
• Although the powdered activated carbon turnaround has materially improved profitability, management acknowledges that PAC’s structural growth potential is more limited than granular activated carbon. If GAC continues to drag on results while PAC growth normalizes, consolidated revenue growth and earnings momentum could fall short of what would be required to justify a significantly higher long term share price.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Arq is $7.0, which represents up to two standard deviations below the consensus price target of $8.75. This valuation is based on what can be assumed as the expectations of Arq's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $12.0, and the most bearish reporting a price target of just $7.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $162.0 million, earnings will come to $5.8 million, and it would be trading on a PE ratio of 67.9x, assuming you use a discount rate of 7.8%.
  
• Given the current share price of $3.35, the analyst price target of $7.0 is 52.1% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.