Shares of Avarga, typically thinly-traded, roared into life on Monday, Aug 24, surging as much as 46.1% on heavy volume, drawing the market’s attention to what might have caused the sudden flurry at the investment holding company with interests in paper manufacturing, power generation and building materials distribution.
In an interview with The Edge Singapore, Ian Tong, CEO of Avarga, says that the company is seeing growing demand for its paper manufacturing business and is mulling over ways to fund an expansion in production capacity. In addition, the company is exploring the possible sale of its power plant in Myanmar too. However, investors should take note that there is no certainty of completion, he adds.
Avarga’s executive chairman is Tong Kooi Ong, who is also chairman of The Edge Media Group, the parent company of the publisher of The Edge Singapore. Ian is also an executive director of The Edge Media Group.
“What I will say is that exploring a range of corporate exercises is simply part of what we do on a regular basis, we are always studying ways to optimise shareholder value. We have strong and resilient cash generating businesses with proven long-term track records, and that allows us the flexibility to be patient and look at various options on our terms,” he adds.
Paper and power
For the six months to June 30, the company saw a 5% y-o-y increase in revenue to $720.3 million. Earnings, however, dropped 37% y-o-y to $14.9 million, as the year-earlier bottomline enjoyed a one-off lift of $10.9 million from the sale of an unused property in Tuas that had previously housed the paper operation.
Yet, even as large swathes of the global economy were hit by Covid-19, the company notes that its three businesses have been relatively unaffected. Its paper business, which makes packaging material used in cardboard boxes, is in fact, an indirect beneficiary of growing e-commerce volumes. “We are kind of riding on the tailwinds of this e-commerce growth — because of Covid, you’re seeing e-commerce adoption being accelerated [by] years,” Ian explains.
While the paper plant today is “well-optimised”, and is already running at almost optimal efficiency, if this business is to grow further, it would require an expansion of capacity or upgrading of the existing facility, he adds.
Besides the planned expansion of the paper business, Avarga is exploring the possible sale of its Ywama power plant near Yangon, Myanmar. Under a 30-year agreement that will end in 2044, the Myanmar government will buy at least 350 million kilowatt-hours (kWh) a year from the plant at a tariff rate of 3.4 US cents (4.6 cents) per kWh. Given how Myanmar’s economy is growing and how power generating capacity is still rather limited, Avarga has generally sold slightly more than the minimum offtake, says Ian.
The plant, which cost US$46.5 million, has already paid for itself and there is no pressure to sell. If potential buyers could not offer their required terms, Ian will be happy to continue owning this plant with its stable income.
Lumber gains
The bulk of Avarga’s revenue actually comes from its 69.7%-owned building materials business, Toronto-listed Taiga Building Products, which distributes building materials such as lumber, panels, mouldings, engineered wood, and roofing.
Established in 1973, Taiga is Canada’s largest wholesale distributor of building materials. It currently has 13 distribution centres in Canada and three in the US, with some 80% of sales from Canada, and the rest from the US. It was also the only one out of Avarga’s three businesses to see a 6% y-o-y growth in revenue to $692.5 million for 1HFY2020 ended June. However, gross profit in 1HFY2020 jumped 17.8% to $75 million, thanks to much better margins.
Prices of lumber have doubled thus far this year to more than US$800 per thousand board feet. The surge of this commodity was triggered by an unusual divergence of supply and demand.
When Covid-19 hit, many lumber mills, anticipating slowing demand, cut back production. Yet, demand went up as more homeowners chose this time to refit and renovate, thereby driving up demand even as inventory levels have become low. “Maybe it’s stimulus-related or shifting of budget from travel and entertainment, maybe it’s the whole work from home (WFH) trend, we saw a lot of demand in renovation and remodelling during April to mid-May,” Ian notes.
“In the middle of May, we started seeing US housing really pick up steam. Along with record low mortgage rates, I guess people were looking at single-family housing outside of the big urban cities like New York, and looking at properties at places in Florida, for example. It would be a while before we can really determine whether this relocation to single-family housing is a secular trend, but Taiga would be a likely beneficiary if it is,” he adds.
However, Ian cautions that higher margins in 1HFY2020 is “somewhat of an anomaly” due to the quicker-than-expected divergence in supply and demand, which will not “continue indefinitely”
“When we start to enter the winter season and construction slows down, you’ll likely to see more normalised margins as the supply-demand dynamic works itself out. If lumber prices start to drop, that would reverse some of our margins — which is what we’re being cautious about, even though we turn our inventory very quickly,” he says.
In any case, Taiga, Ian notes, is a very defensive, stable business that has been around for almost 50 years. “What most people don’t understand, is that it is naturally diversified. We benefit both from renovation and remodelling and new housing starts which are negatively correlated due to labour economics.”
Furthermore, with a wide geography and expansive distribution network, it has more resilience. “Different states go through different housing cycles,” he explains.
“Finally, because of our size, our product range is very wide — even when lumber is in a downtrend, allied or manufactured products, which make up half of our sales, buffers our bottomline due to their higher margins,” he says.
Taiga bought a US distributor in 2018 which expanded its network across the West Coast of the US. Ian would not speak on specific plans for future growth or acquisitions, but acknowledges that there are a variety of growth levers the company is studying, given the dominant market position it enjoys.
However, Ian emphasises the focus is on the existing operations. “What we’re good at is being a low-cost logistics operator. It’s about efficiency, and continued improvement lets us both defend our market position and generate incremental gains,” he says.
Diversified business
Contrary to what some analysts think, Ian disagrees with the notion that entities with a similar structure should be valued with a holding company discount. He argues that having different businesses operating out of different markets makes Avarga’s performance resilient and that diversified cash flows allows the company to access credit at favourable rates. He compares this to the typical investor’s portfolio: “I have never met someone who held a single stock portfolio.”
In addition, capital generated can be allocated where it is most effective within the group or other investments. For example, Avarga has been buying back shares. The most recent purchase was on Aug 17, when a total of 539,800 shares were bought back at between 14.7 cents and 15 cents.
Since Ian took on the CEO role earlier this year, Avarga has tried to be more shareholder-friendly. On June 25, the company announced a new dividend policy whereby it would pay out at least 40% of its annual earnings and the dividend will be distributed quarterly with effect from 2HFY20. With the exception of REITs, most listed companies pay only an interim dividend, if any, for the half year, plus a final dividend. DBS Group Holdings is a notable exception. To Ian, paying dividends quarterly is a sign of confidence in Avarga’s cash flow.
Since the initial move on Monday, Aug 24, its share price continued climbing. It hit an intraday high of 34 cents on Thursday, Aug 27, before ending the day at 26 cents. Year-to-date, it is up 62.5%.
At this level, the company is trading at 10.51 times historical earnings and has a market value of $251.8 million. Toronto-quoted Taiga Building Products closed at C$1.31 ($1.36) on Aug 26, up 13.9% year-to-date, and valuing Avarga’s stake at C$100.24 million.
