Avarga Limited (U09): Paper, Power, Taiga |Current: $0.25| Target: $0.42 |Upside:+69%|

Introduction 

Avarga is an investment holding company focused on creating value through strategic investments. The Group has businesses in paper manufacturing (paper), power generation (power), distribution of building materials (Taiga) and property investment holding. Founded in 1967, the Group is headquartered in Singapore, with business operations and assets in Malaysia, Myanmar, Singapore, Canada and the USA.

At S$0.25 per share, Avarga is valued at S$219m. With a trailing P/E of 13.3x*, I believe this company is undervalued and has substantial upside potential.

*due to the note restructuring on 17 Nov 2017, for accounting purposes, one-off non-cash extraordinary items were expensed off (AR17, pg 6). Trailing Core P/E is much lower, around 8-9x.

 

The Management & Board

Tong Kooi Ong, Executive Chairman & CEO: 25.31%

Ong Pang Liang, Independent Director (ID): 0.57%

Kalimulah Bin Masheerul Hassan, ID:            3.42%

Ng Shin Ein, ID:                                              0.06%

Tong Ian, Executive Director:                        0.32%

Garson David Lee, ID:                                  0.15%

Total                                                          29.83%

Note: Peter Lim Eng Hock, previously controlling shareholder of Avarga, owns 20.9%.

Management & Board owns a significant stake in the business, a total of 29.83%.

In 2012, Tong bought a 26.92% stake in a struggling UPP Holdings (renamed Avarga) from Lim and other parties at approximately $0.17 per share. From 2012 to 2017, Tong successfully turned the paper business around and added 2 profitable businesses, Power (in 2014) and Taiga (in 2017).

The 3 Businesses

  1. Paper

The Group’s pulp and paper mill in Ijok, Malaysia, is one of the five largest in Malaysia and produced almost 10% of the country’s domestic annual production of industrial brown paper. Its products include test liner, corrugated medium and core board, which are used to manufacture a wide range of paper packaging products. The plant is currently operating at almost full capacity and has a vacant 5-acre site available for future expansion. The paper manufacturing business in Malaysia saw a revenue growth of 24% from 2011 to 2016 and a net profit increase of 7 times from RM3.5 million to RM23.6 million, with additional investment of only RM2.4 million in 2015 to increase capacity. EBITDA margins improved from 9% in 2011 to 18% in 2017, while ROA jumped from 1.6% to 9.6% despite rising cost of energy and wages (AR17 pg5).

Paper Outlook

  1. Malaysia’s ban on exports of local waste paper (raw material for Avarga) keeps domestic prices low.
  2. China’s recent ban on import of waste products has created surplus supply and falling waste paper prices in the international market.
  3. At the same time, China’s domestic paper prices and production costs are rising.
  4. Strong demand for carton boxes, due to bulk and consumer packaging needs, especially with increasing e‐commerce activities (see chart above).
  5. “One of the key drivers for packing boxes is the rapid growth in online sales, which also tend to use smaller boxes (compared with those used by traditional retailers). Smaller pack boxes require significantly more square metres of containerboards to ship the same amount of goods.” – Tong

Paper Forecast & Valuation

Assuming sales growth of 2.2% (in line with 5-yr CAGR) and pre-tax margin of 15.5% (below 2016’s 15.7%), we get a net profit of 6.5m. Given the positive outlook mentioned above, I think those are conservative input values.

Paper business’ comparables have done well with a median 1-yr share price performance of 44.8%. Avarga has lagged in this case, down 12.2% (0.285 to 0.25) from a year ago. The comparables trade at an average and median P/E of 15 times. Given the small size of Avarga’s paper business, I will use a 10x multiple (33% discount) as a base case.  This leaves us with a relative value of 65.3m for the paper business.

2. Power

Avarga owns a 50 MW independent power plant (IPP) project in Yangon, Myanmar. The gas-fired power plant commenced operations in 2014, and is one of Myanmar’s first fully-foreign owned IPPs. The plant supplies power to the national grid under a 30-year power purchase agreement (PPA) with the state-owned Electric Power Generation Enterprise, under Myanmar’s Ministry of Electricity and Energy. There is a minimum guaranteed take-up rate of 350m kWh per year paid in USD, this provides about $7m annually in pre-tax profit (AR17 pg5). The plant provides about 2% of Myanmar’s current electricity generation.

Power Outlook 

  1. Myanmar has one of the world’s lowest electrification rates at under 40%
  2. Limited gas resources, other fuels & antiquated transmission lines limit major new power sector investments

Power Forecast & Valuation

Given the business is operating on a 30-year PPA with 27 years remaining with visible, stable, and recurring revenues, we use a DCF method to value the segment. Assuming free cash flow to the firm of 6m annually and a weighted average cost of capital of 5.97%, we get a net present value of 82.9m.

3. Taiga

In Feb 2017, Avarga acquired a 54.8% stake in Taiga Building Products Limited, listed on the Toronto Stock Exchange. Taiga is Canada’s largest wholesale distributor of building materials, such as lumber, panels, mouldings, doors, engineered wood, roofing, insulations and others.  It has 15 distribution centres across Canada, from Nanaimo in Vancouver Island in the west, to Paradise, Newfoundland in the east. Distribution sales into the USA are through 2 distribution centres in California and 6 reload stations in the states of Pennsylvania, New York, Michigan, Vermont and Illinois. Taiga’s competitive advantage/moat lies in it being the lowest cost operator and its established supply & distributorship relationships and direct railroad access to most of its sites. Some of Taiga’s customers include Home Depot, Lowe’s, Rona, and HomeHardware.

Taiga Outlook

Lumber is a major product component of Taiga’s business. Its annual sales are positively correlated to lumber prices. As you can see from the chart above, lumber prices are at multi-year highs and have been increasing rapidly as of late.

The next 5 slides paint an interesting macro trend that augurs well for Taiga, I came across fundstrat’s data/slides during a bitcoin presentation earlier this year, you can watch the youtube video here…

 

Basically, millennials, who are currently the largest demographic group, are just entering into their home purchasing years. Historically, every generation (Gen X, Baby Boomers, etc) has driven a multi-year housing boom as they entered into this phase, this time will not be any different, barring any unforeseen circumstances. Government statistics seem to agree too, housing activity has been consistently increasing over the years in US and Canada, the 2 key markets for Taiga.

Taiga Forecast & Valuation

Pre-2017, due to tax purposes, Taiga was structured like an Income-Trust. By issuing 14% subordinated debt, noteholders/shareholders could receive income without being taxed. This meant that although Taiga was generating cash flows, most of it went out as interest expense and little was retained. This form was eventually ruled out by the Canadian government. In Nov 2017, Taiga had its 14% notes restructured mostly into new shares (for more details refer to Appendix A below). This exercise strengthed Taiga’s balance sheet significantly, lead to annual interest savings of C$18m, but it also meant that more cash will flow to the bottom-line. Taiga’s shareholders (Avarga’s a 49% shareholder too) are clearly the winners.

Assuming sales growth of 10% (past 3 quarters of sales growth year-on-year grew 16-19% on higher lumber prices, refer to Appendix B for more details) and EBITDA margin of 3.3% (in line with recent years), we have an EBITDA of 50.5m.

Taiga’s comparables are trading at a median EV/EBITDA of 11.1x.  If we use a 9x EV/EBITDA, we get 222.9m (based on Avarga’s 49% stake). One would not be wrong to say that Taiga presents a better investment opportunity than Avarga itself. In fact, both Avarga and Taiga would like to purchase more of Taiga:

“Our immediate focus for 2018 will be an attempt to acquire more of Taiga. The reasons are the same as when we first acquired the controlling interests. Simply put, it is value-accretive for (Avarga).” – Chairman & CEO Statement, AR17 pg 12

On 27 April 2018, Taiga announced its intention to buy back up to 5% of itself (see below). The share purchased will be cancelled, increasing the value and percentage stake of the remaining shareholders.

The Valuation

Adding the 3 businesses up, we get a SOTP value of 371.1m or 0.42 per share (+69% upside). This value does not include the yet to be confirmed acquisition of an additional 15.8% of Taiga by Avarga announced in Mar 2018 (refer to Appendix A for more details).

At 0.42 per share, it is still 4.5% lower than the share price of 0.44 achieved in Apr and Oct 2012 when Tong took over Avarga with only the paper business. 

There are currently no analysts covering this counter. 

 

Potential Privatization

This is purely speculative but not without basis:

Should the 15.8% stake in Taiga deal go through, it will increase Tong’s stake in Avarga to 31.09 Under Singapore’s code on takeovers and mergers, Tong will be required to make a mandatory general offer for the shares he does not already own unless granted a waiver by the Securities Industry Council. The deal is subject to approval by shareholders and obtaining a waiver, as well as Avarga being satisfied that the proposed acquisitions do not require notification under the Competition Act (Canada).

Tong and Lim could offer S$0.30-0.375 per share (20-50% premium, S$130m-165m total sum) for the remaining 49.6% of Avarga

 

Dividend Analysis 

Avarga has paid increasing dividends annually since 2010. Dividends grew at a CAGR of 39% from 0.1 cents in 2010 to 1 cent in 2017. Since the group’s dividend payout ratio has historically averaged 0.68x, there is much room for growth in dividends (i.e. increased earning or increased payout ratio or both). At the current share price of $0.25, the dividend yield is 4%.

Avarga has a dividend policy of $0.01 per share for each of FY16, FY17 and FY18, and will review its dividend policy for the fiscal years thereafter (AR17, pg 37).

 

Insider Trades & Share Placement

Recent insider purchases made by Tong Kooi Ong and Ng Shin Ein ranged between $0.255-0.27 per share.

Share placements were carried out on 2 occasions in 2012 and 2017 at an offer price of $0.375 and $0.25 respectively.

At the current share price of $0.25, investors would be getting a better deal than them.

 

Stellar 1QFY18 Expected

Avarga’s 1QFY18 results will see significant improvement year-on-year given the positive outlook on its 3 businesses, especially Taiga, where lumber prices have been at multi-year highs. 1QFY18 will include all 3 months of Taiga’s financials instead of just 2 months last year when it was acquired on 31 Jan 2017. The full impact of the interest savings will also be reflected vs. 1QFY17 where the 14% notes still existed.

 

The Risks

  • Paper
    • Business is cyclical
  • Power
    • Operating in an uncertain socio-political environment
  • Taiga (to see how risks are being managed, do read AR17 chairman’s statement)
    • Business is cyclical
    • Lumber prices fall substantially
    • Margins are razor thin
    • High levels of short-term debt needed to finance inventory

 

The Bottomline

  • Dividend Yield of 4% with ample room to grow
  • Management with a significant stake in the business
  • Current price below recent insider purchases
  • Paper: A proxy e-commerce play
  • Power: Stable recurring income till 2044
  • Taiga: Hidden gem with massive cash flow post debt-restructuring
  • SOTP of Paper, Power, Taiga is S$371m or $0.42 per share (+69% upside)
  • Potential privatization play with 20-50% upside (purely speculative)
  • No analyst coverage => significant re-rating potential
  • 1Q18 will show significant improvements

Note: Taiga’s 1Q18 results should be out on 04 May 2018 after market close. (Refer to forecasted results in Appendix B)

Note: Avarga’s 1Q18 results should be out on 11 May 2018 after market close. (Refer to forecasted results in “Stellar 1QFY18 Expected” above)

 


APPENDIX A – TIMELINE OF EVENTS

15 Mar 12

  • Tong Kooi Ong joins the board as Executive Chairman & CEO

04 May 12

  • Share placement of 110m new ordinary shares
  • Offer price S$0.375
  • Net proceeds approx S$40.3m
  • Purpose: (a) 70% pursue such investments and opportunities as and when they arise; and (b) approximately 30% of the net Placement proceeds for working capital purposes of the joint venture company to be established in Myanmar in which the Company will have a 67% interest.

Feb 2014

  • Ventured into Myanmar power business
  • 30-year PPA with minimum guaranteed take-up rate of 350m kWh per year

31 Jan 17

  • Acquired 58.34% of Taiga @ C$1.00 per share

13 Feb 17

  • Avarga issue bonus share warrants
  • 1 for 1
  • Exercise price S$0.37
  • Expiry 12 Feb 2020

07 Mar 17

  • Share placement of 40m new ordinary shares
  • Offer price S$0.25
  • Net proceeds approx S$9.9
  • Purpose: reduce bank borrowings

17 Nov 17

  • Taiga loan note restructuring (“Exchange Offer”)
  • Taiga had C$128.8m of 14% unsecured subordinated notes (“Loan Notes”), callable at par from 1st of Sep 17
  • Noteholder had the option of either: exchange for new 7% 5-year senior notes of Taiga or convert to shares at a rate of C$1.20 per share or combination of both or have the note called.
  • 78.6% chose to convert into new shares (as a result, Avarga’s % stake in Taiga decreased to 49%)
  • 9.7% chose to convert to 7% 5-year senior notes
  • 11.6% were fully redeemed
  • Interest savings on 14% subordinated notes is approx. C$18m annually
  • Incorporating this and the other one-off non-cash accounting charge of C$18.6m relating to the exercise, Taiga’s Pro-forma pre-tax profit for Jan-Dec 17 would have been C$36.8m instead of C$3m.
  • As a result, Taiga net gearing fell substantially to 0.4x

24 Mar 18

  • Avarga buys 15.8% stake in Taiga at C$1.50 per share, % stake increased to 64.8%
  • The deal is subject to approval by shareholders and obtaining a waiver, as well as UPP being satisfied that the proposed acquisitions do not require notification under the Competition Act (Canada).

 

30 Apr 18

  • Taiga announces normal course issuer bid
  • Taiga may buy up to 5% of total outstanding common shares of itself
  • Common share bought back will be cancelled, increasing Avarga’s % stake in Taiga

May 18

Taiga Q1FY18 results

  • Opinion: Substantial improvements in bottom-line due to interest savings from loan note restructuring

Avarga Q1FY18 results

  • Includes 1 additional month (Jan) of Taiga’s financials (Q1FY17 only included Taiga’s Feb and Mar financials)

APPENDIX B – FORECAST OF TAIGA Q1 RESULTS

Assuming year-on-year sales growth of 10% and the respective common size fractions/percentages from 1QFY17 superimposed on 1QFY18, we could see pre-tax profit rise by 700+% and net profit by 1,900%.

Kenny Chia

Value-Growth Investor

2 thoughts on “Avarga Limited (U09): Paper, Power, Taiga |Current: $0.25| Target: $0.42 |Upside:+69%|

  • May 12, 2018 at 4:08 PM
    Permalink

    thank you very much … u did a lot of work. im impressed.

    im invested, but playing devils advocate (or if you want to see it another way, errors)
    i took 10min to look through your report, so i might have made some mistakes…

    1) only an idiot will invest in Myanmar for 5.97% ROE. People invest in India Power Sector for 15% ROIC, Myanmar is frontier, this would be more like 15-20% ROE. i think even Singapore Power ROE is higher than 6%.
    i believe should have taken some debt on this investments too.
    If you change your ROE assessment, i wonder how much that asset is worth.
    Why not look at how much it cost to build that plant too?
    Another way of looking at it, it will cost about USD1,000 per to but 1 kW of gas fired power plant now, so 50MW would cost USD50m. U probably can adjust lower for land cost and lower labour cost, but around there.

    2) Taiga issued subordinated debt at 14%. Since its supposed to be like equity, seen another way, it means that their ROE expectations is at least 14%, which means P/E would be 7x area.
    im a bit skeptical by 9x EV/EBITDA valuation, but it

    3) Your 222.9 value on Avarga stake in Taiga, is on EV. Taiga has about CAD100m+ of debt, as per yahoo finance.
    You seem to be mixing up EV, equity value in your sum of parts calculation.

    4) do you know how much debt they have at the Avarga limited holdco level?

    Actually, i dont get why they like to issue dividends when they have growth opportunities.

    hope it helps. but please dont sell. 🙂

    cheers.

    Reply
    • May 14, 2018 at 4:46 PM
      Permalink

      Hi Ken

      Thank you for your input. Yes, there are errors in my write up (esp. the Non-controlling interest part of my 1Q18 forecast). I hope to improve my level of analysis with constructive criticisms from readers such as yourself.

      1) Yes I agree. A higher rate should be have been used to value this asset. Assuming FCF of $7m and a WACC of 15%, NPV is about $52m (-36%) close, to your replacement cost method. Ceteris paribus, SOTP will fall to 0.37 (-12%).

      2) You can view it that way. EV/EBITDA multiple can be adjusted to your comfort level.

      3) The CAD100m+ mainly consists of the revolving credit facility used to finance its trade receivables. The credit facility’s level of drawdown is seasonal. I have omitted it in my calculations.

      4) From 1Q18 financial statements, holdco has no debt.

      Tagia has recently rescinded its dividend policy and is “pursuing growth opportunities”.

      Reply

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