Avarga Ltd (SGX:U09) is set to benefit from the huge spike in lumber price. Avarga Ltd is an investment holding company and its crown jewel is Taiga Building Products Ltd, a wholesale distributor of building materials in North America.
Increase in homebuilding and renovation demand, combined with production cuts due to Covid-19, has caused lumber prices to hit an all time high at $830.9. Therefore, this will have a positive impact on Taiga’s top and bottomline.
My valuation showed that the fair value of the company could go up to as high as $0.52, depending on the recovery of North America’s housing demand and the sustainability of high lumber price.
Taiga Building Products Ltd
Established in 1973 and listed on the Toronto Stock Exchange in 1993, Taiga is Canada’s largest wholesale distributor of building materials, such as lumber, panels, doors, engineered wood, roofing and others. Its products are mostly used for new residential landed residences and for renovations.
It has 15 distribution centres across Canada and 2 in USA. Distribution and sales into the USA are through 2 distribution centres in California and 6 reload stations in the East Coast.
Taiga operates 3 wood preservation plants that produce pressure-treated wood products, used principally for outdoor decking and fencing. Other than pressure-treated wood products, all other products sold are sourced from third party manufacturers, principally from Canada and USA. They also have sources from Asia and Central and South America.
Taiga’s customers range from the retailers in North America, such as Home Depot, Lowe’s and Rona to the huge number of widely dispersed smaller and neighbourhood lumber yards and hardware stores.
The strengths of Taiga are;
- The comprehensive and varied building material products it distributes
- Its relationships with both suppliers and customers
- Its strategic locations and the company being the lowest cost operator per dollar of sales in the industry.
- Wide product mix of its sales, huge distribution capabilities, and the high level of efficiencies.
Avarga has a 67.9% stake in Taiga Building Products Ltd.
The Supply Chain Screw Up
When COVID-19 happened, the pandemic has caused all sectors to shut down, including residential construction. Due to the uncertainty of future demand and the consumption of lumber, the production side witnessed a complete collapse in demand. The sawmills had to make the hard decision of curtailing production.
Against that backdrop, Canadian lumber shipments to the U.S. for the second quarter, year on year, were down by 19%.
Meanwhile, the backlog of existing business (on the books pre-COVID-19) proved to be very large and the expected void in housing and lumber demand has been less severe in both quantity and duration throughout the ongoing pandemic.
Sawmills will take weeks to come back online. The industry needs time to rehire laid-off workers, retool equipment and rebuild the transportation chain to ship the wood out of the mills. This has led to a supply crunch of lumber.
Recovery in North American Housing Market
There are reports saying that recent data such as housing starts and building permits are showing an increase in demand for building products.
This is partly the reason why we saw huge increase in same store sales in DIY names like Home Depot.
https://ir.homedepot.com/news-releases/2020/08-18-2020-110014886
This Is Not The Start Of A Housing Boom
However, I am of the opinion that there isn’t any new “net” demand. What we are currently seeing, the unusual high demand, is due to the “unspent” demand in 1H 2020. This is now being spent as make up additional demand. So I feel that this is a recovery and not the start of a housing boom.
People have pushed back their pre-virus home renovation and purchasing plans until the virus is less of a threat. So it appears that there is new demand but it’s not. Eventually, demand will slow down and production will catch up with demand. When that happens, we could see a correction in the later part of the year.
My acquaintance who worked in forestry in Canada also agreed that lumber demand has not changed much on a yoy basis. The shortage is due to the strategic production curtails, planned shutdowns and permanent closure of mills. He also mentioned that most of the lumber produced in Q1/Q2 didn’t ship due to Covid 19 supply chain disruptions and that caused a shortage in lumber in both Canada and USA.
Of course, I could also be wrong as there is the argument that low interest rates and the increasing consumer confidence will fuel an increase in new home sales. This could mean that there really is a net increase in housing demand.
So to be conservative, I will only factor in the gross margins improvement that Avarga/Taiga will see due to the increase in lumber price but not the potential increase in demand of their products (demand remains the same).
Valuation
My assumptions for my valuation calculations are that the Paper Mill and Power Plant have stable revenue and profit. Sales for building products are similar to FY2019 but gross margin and net margin improved from 10% to 15% and 2% to 4% respectively.
From my assumptions, it seems like there is still alot of upside for the share price to appreciate.
3Q20 should be their strongest quarter as building products biz is seasonal and the increase in “unspent” demand in 1H20. It goes strong from spring to fall but turns weaker during the winter months. We can revisit these assumptions after Taiga releases their 3Q20 results in November this year. However, as Avarga only reports half yearly, we do not have any visibility for their other businesses until they release their FY20 results in Feb 21.
Do note that this valuation does not take into account the potential spinning off of their paper mill business and the possible transaction to monetise their power plant business (Avarga Ltd mentioned it in their recent response to SGX’s trading query, see below).
Both, if they were to happen, are additional catalysts for a re-rate of their share price.
Risks
- Ability of lumber to maintain at these price levels is questionable as this is more of a temporary supply shock instead of real growth in demand. There is a possibility that we will see a large correction in the coming months.
- The high lumber price could discourage homeowners to proceed with their renovation plans. This will result in lower demand for Taiga’s products, offset by higher margins which we have seen in their Q2 20 results.
- The market is always forward looking and this could be a non-event if this spike in lumber price is very short term and over time they will even out.
Takeaway
Avarga Ltd is set to benefit from the spike in lumber price. An improvement in the gross and net margins of their crown jewel, Taiga Building Products Ltd, will also increase their earnings per share.
My valuation showed that there is still some upside to their current share price.
However, investors have to do their own research on North American housing demand as well as the sustainability of high lumber prices. Any new developments in these areas will affect Taiga Building Products Ltd’s business performance.
Cheers.
I think they report qtrly still. Dyodd
From what I understand, they stopped reporting quarterly this year. Do you have the link to their 1Q20 results?
You can see their dividend policy announced in jun20
I saw that they declared dividends to be paid quarterly. But I don’t it implies quarterly reporting.
https://links.sgx.com/FileOpen/AGM_Presentation_Transcript.ashx?App=Announcement&FileID=621261
If you refer to the transcript of their AGM held in Jun2020, they stated in slide 7 that they have changed to half yearly reporting but dividends are still paid on a quarterly basis. Hope that clears it up. Anyway, thanks for taking time to read my blog. Cheers
It’s a good write up, thanks for the catch.Believe their Q3 will be explosive. That’s something new where dividend declare without qrtly reporting.
A very sound analysis, just read it and you’re almost spot on for Taiga based on its actual 3Q run rate. Both Avarga and Taiga are extremely undervalued given how conservative the business is financed and top notch management with significant skin in the game.