Avarga’s Portfolio Companies and Management

Many investors see Avarga only as a proxy to Taiga building products. They have good reason to do so since Taiga is the biggest company in Avarga’s portfolio and contributes the most profit. But Taiga is trading at an attractive valuation itself, with a PE ratio only 4.36 compared to Avarga’s 5.60. So if an investor sees Avarga only as the owner of Taiga, won’t they be better off just buying Taiga’s shares instead?

I like Avarga and its portfolio, but I do like Taiga a little bit more than the other portfolio companies. So I have bought some shares in both Avarga and Taiga. It is up to the individual shareholder’s preference of course. But I would like to write about what you are getting yourself into when you invest in Avarga.

Avarga’s Portfolio Companies

1. Taiga Building Products (lumber and building materials distributor in North America):
Avarga’s main subsidiary with a stake valued at about S$245m. Taiga’s share price is severely undervalued in the context of the lumber and building boom in North America. I have written about Taiga’s prospects in more detail in the previous post.

Taiga has been doing extremely well, and their prospects remain bright. The main problem I have with Taiga is that it is based and listed in Canada with super high tax rates. Aside from a high tax on profits, Canada also has high taxes on capital gains and dividends. In 2020, Taiga paid C$25.4m of income taxes resulting in net earnings of C$70.8m. That is a tax rate of around 26.4%. On top of that, when they declared dividends, there is an additional witholding tax of 25%. To illustrate, if Taiga makes a profit before tax of $100 and wants to give it all back to shareholders, the shareholders will end up receiving only about $55 after all those taxes!

This witholding tax is a huge deterrent for the declaration of dividends. So Taiga generally does not declare dividends. Avarga has therefore funded its dividends from the cashflow of UPP Paper and the Myanmar power plant instead.

2. UPP Paper (producer of brown paper for making cardboard): UPP paper buys waste paper and recycles them into brown paper that is used for making cardboard. This is the original business of Avarga since 1971 After all, Avarga used to be called UPP before undergoing a name change. Profit before tax for this business was S$8.1m in 2019 and S$5.1m in 2020. There is a high and growing demand of UPP Paper’s products because of the rise of online shopping. Those of you who buy stuff online will know that your items often come in some form of cardboard packaging. This is driving up the demand for cardboard and hence, UPP Paper’s products.

What causes fluctuations in profits is therefore not demand, but costs. The price of waste paper is very volatile because the main consumer of this material, China, has been changing their policy on this. China has issued a ban on imports of waste paper from 1 Jan 2021. This caused China’s own brown paper manufacturers to import a crazy large amount of waste paper in 2H2020 to stock up before the ban kicks in. Consequently, they drove up the prices of waste paper in the rest of the world including Malaysia, causing an increase in UPP Paper’s costs in 2020. The good news is that since the ban is now in place, those countries who used to export waste paper to China will lose a big customer. We can therefore expect prices to be lower in 2021 onwards for UPP Paper.

These developments have also driven some paper manufacturers to move out from China to set up shop in Malaysia. It is too early to tell how big an impact this will be on UPP Paper. But UPP Paper has been aggressively lowering costs to be the most efficient player in the Malaysian market. They are now mulling an IPO to raise funds for expansion so as to get more economies of scale to compete and win against any potential new competition. Apart from operational benefits, an IPO will also give Avarga’s investors a better appreciation on the value of this business segment.

3. UPP Myanmar (owner of a power plant near Yangon): Avarga had invested S$58.7m to build a power plant in Myanmar. According to the World Bank, Myanmar has the lowest electrification rate in South East Asia with only 50 percent of households connected to the public grid. This means that there is still much room for electricity demand to increase in Myanmar. Indeed, in Avarga has exceeded their annual production commitment of 350 million kWh under the power purchase agreement every year since the power plant was built in 2014. As a utility business, this power plant has been generating very steady cashflows for Avarga. They have an ROI of about 11.9% and enough cashflows to have recouped the investment cash-wise within 5 years.

Unfortunately, a coup has occured earlier this year in Myanmar. There as been a lot of chaos and Myanmar is on the brink of becoming a failed state. Despite this, the power plant’s operations have not been affected. Both the military and the citizens still need electricity. But things can still go further downhill. I will share more of my views on this Myanmar investment in the section on Avarga’s management below.

4. Classic Scenic (producer of wooden picture frames): Avarga had invested S$2.8m for a then 4.98% stake in 2016. From the 2016 report, the Chairman explained the investment rationale as “The company manufactures custom photo frames in Malaysia and is listed on Bursa Malaysia. Almost all of its sales are exported and are denominated in USD. Some 80% of its sales are to the USA, primarily to Michael’s, Hobby Lobby and Larson Juhl. Michael’s is the largest arts and crafts retail chain in the USA, with over 1,200 stores. In 2015, Classic Scenic had revenue of RM54 million and a high EBITDA margin of 31.2%. With the weakening ringgit, margins and profits expanded further in 2016. The investment also effectively provided us a currency hedge for our ringgit deposits, as Classic Scenic’s earnings are USD-based.”

The share price of Classic Scenic is now around RM1.52, which is a bit higher than the RM1.42 that Avarga paid for. In March 2021, another Malaysia listed company (Complete Logistics) bought a 14.94% stake of Classic Scenic at RM1.63 per share, which is higher than what Avarga had paid for. Complete logistics pointed to Classic Scenic’s consistent track record of profitability and dividend payouts as reasons for their investment: (https://www.theedgemarkets.com/article/complete-logistic-acquires-1494-stake-classic-scenic-rm29m).

5. Straits Inter Logistics (bunker fuel supplier): Avarga had invested about S$4.5m in March 2021. The share price has risen and the stake is now worth about S$6.1m. Straits Inter Logistics effectively operates as a mobile petrol station in the sea. They supply fuel to container ships, cruises & ferries, oil rigs & OSVs. Bunkering services should see healthy demand in the coming years as tourism and offshore O&G picks up.

Avarga had also reportedly express interest in “strategic collaborations with Straits Inter Logistics (https://www.theedgemarkets.com/article/singaporelisted-avarga-takes-substantial-stake-straits-inter-logistics). However, there has not yet been any news on what these “strategic collaborations” might be. I hope Avarga management can give an update to shareholders regarding Straits Inter Logistics soon.

6. Archisen (smart urban farming solutions): Avarga had invested S$0.5m for a 9.09% stake in 2018. This is a non listed company so not much is know about their financials. But I assume that it is loss making as it hasn’t quite scaled up yet. Avarga had committed to S$1.5m investment to be made in three S$0.5m tranches, with certain conditions to be met before tranches 2 and 3. Since they are stuck at tranche 1, Archisen probably isnt growing as well as they expected.

However, their technology in smart urban farming might do better in the next few years given Singapore and other cities’ efforts to improve food supply security. You can read about one of Archisen’s recent projects here: (https://www.straitstimes.com/singapore/new-smart-urban-farm-takes-root).

Management

Minority shareholders can easily be bullied and taken advantage of, especially for SGX listed stocks where the controlling shareholder is often also the management. The only way to assess if management is decent is by looking at their track record. As I see it, the Tong family has proven themselves. Management has successfully transformed Avarga from a paper manufacturer to a very profitable investment holding company, including their spectacularly successful investment in Taiga. Avarga has grown tremendously in both profits and cash flow, and have given out regular and growing dividends.

The Executive Chairman has also taken the time to write a very detailed letter to shareholders each year. For most companies, the letter to shareholders are dull and probably written by PR firms. But not for Avarga. The Chairman will go into detail on operating results, key business decisions, and give his views on the company’s prospects. I encourage all investors and prospective investors to read the Chairman’s letter for all their annual reports from 2012 onwards. You will find it quite refreshing and insightful.

Myanmar coup – Competence highlighted in a crisis

When Myanmar opened up in 2012, there was a lot of interest in doing business in the country. Myanmar had so much potential, having started from a low base. It was mired in poverty and underdevelopment. Yet it had a large, young and growing population of more than 50 million, and is even rich in natural resources such as jade, rubies, and oil. The was so much growth potential for the country. Amidst the rush of potential investors, Avarga (then called “UPP”) managed to be among the first to get a foothold in Myanmar (probably thanks to Tong Kooi Ong’s business connections). Between 2012 and 2013, Avarga had three serious potential investment opportunities in Myanmar.

Building and operating a power plant near Yangon
Joint venture to develop an industrial park in Mandalay
Joint venture in a quarrying business (crushing rocks and supplying the crushed rocks for infrastructure projects such as dams)

However, Avarga maintained discipline in its risk management. They did their due diligence and insisted on certain preconditions before committing to any deal. At the end of the day, they went ahead with only one out of the three opportunities – the power plant.

I have included an extract of the 2013 annual report below. You can find the announcements relating to the MOUs in Avarga’s website.

As you can see, management has shown that they would not take just any deal, but only good deals that meet their strict investment criteria. I don’t take this for granted. Many companies are hasty in making investments/ expansions when a ‘hot’ opportunity arises, only to find themselves being ripped off (SingPost is a good example). In the 2018 annual report, when a coup was regarded as a remote possibility by most, Avarga’s management had again mentioned that business in Myanmar came along with a “Myanmar risk”. They highlighted the Myanmar power plant’s high ROI and cashback (they had already recouped the entire investment on a cash basis by 2018), which is high for a utility business (but commensurate to the “Myanmar risk” taken).

The terms of the power generation contract also addresses the key risks. You can read their announcement on the contract here: (https://repository.shareinvestor.com/rpt_view.pl/id/c8ac716845e46bbbb7d38bc72051800835d7eaf0b9886e3dfe43396222b07457/type/si_news), but the main points I want to highlight is:

The feedstock (gas) will be provided by the Myanmar government at no cost. So Avarga is shielded from volatility in gas prices
Prices are fixed in USD (US$0.034 per kWh). So Avarga is protected from forex and price fluctuations.
There is a guaranteed annual minimum off-take of 350 million kWh, so Avarga can have visibility of a minimum annual revenue in USD over the 30 years of the contract until February 2044.
The offtake contract is signed with the Department of Electric Power (under the Ministry of Electric Power of Myanmar (“MOEP”). So default risk is low, although this has now become a big question mark because of the current political situation.
The construction and operations of the power plant was outsourced to the Myanmar dealer of Caterpillar. So, operational costs is also more or less fixed. With a minimum revenue and fixed costs locked in under the operational contract, Avarga would have locked in a minimum level of profit on the power plant.

There is always an element of risk in business. The worst can happen, like it has now in Myanmar. But as I see it, Avarga’s management has done what it could to manage the risk. In fact my view is that management had in mind the possibility of a coup all along when they were speaking of “Myanmar risk”. They have acted on it by investing only in projects with a short payback period.

Now that a coup has happened and the outlook for Myanmar has dimmed, shareholders like myself can look back with some relief and gratitude that they did not go all in for all 3 projects. It is of course management’s job to have robust due diligence and risk management. Buy having invested in stocks for more than 10 years, I know – and you know – that in reality, good management is hard to come.

Due to it being an essential services provider, the operations of Avarga’s Myanmar power plant has not been disrupted even today. This is good news for shareholders. But this information is not enough. I hope management can also provide us an update on whether they are having any problems collecting payment for the power generated.

The Edge and the Grab connection

It is well known that Tong Kooi Ong and Ian Tong are the Chairman and Executive Director of The Edge. Needless to say, the Tongs have extensive experience and research resources at their disposal. Being a holding company, Avarga presents an opportunity to somewhat invest alongside the Tongs.

One risk Mr Tong Kooi Ong though, is that he is a potential target of political persecution in Malaysia. Afterall, he did (rather heroically) play a crucial role in exposing the 1MDB scandal.

A perhaps lesser known side of Tong Kooi Ong among Singaporean investors, is that his son-in-law is none other than the Grab CEO Anthony Tan. They are already working together in some ways. In November 2020, Malaysia awarded 8 licences for online moneylenders. One of those licences was awarded to Grabfin, which is “60%-owned by The Edge Media Group chairman Datuk Tong Kooi Ong and 40% by Grab Financial Services Asia Inc, according to the Companies Commission of Malaysia (SSM). Grabfin is part of ride-hailing giant Grab’s fintech unit.” (https://www.theedgemarkets.com/article/online-moneylenders-gear-serve-smes).

We should not get our hopes too high on this, as Avarga is probably but a tiny portion of the Tong family’s portfolio. But it would be great if there can be some collaboration with Grab. Perhaps Avarga can get a slice of Grab’s shares before they list. Or they can work with Grab on transport solutions for the Taiga’s lumber distribution business. Slim chance, but we can hope.