The Singapore research team at KGI Securities has given Avarga Limited a fair value of 43 cents in an unrated report dated August 26.

The fair value, which is deemed as the “minimum” for the company, utilises a 10x FY20F price-to-earnings (P/E ratio), which is based on the company’s three-year historical average.

The fair value only takes into consideration Avarga’s “crown jewel”, the 70.8%-owned Canadian-listed building material distribution company – Taiga Building Products. It does not include the value of the company’s paper manufacturing and power plant businesses, which puts Avarga’s valuation “on the conservative side”, says the team.

The team has also estimated Taiga’s 3Q20 earnings to jump 78% q-o-q on the back of higher lumber prices and strong demand in the Canada and US housing market, which has seen more people moving away from cities and towards suburban areas.

Taiga, which runs a business of distribution for lumber and other building materials, is benefitting from the all-time high lumber trading prices due to a shortage in supply and strong demand.

“The inventories of building materials, especially lumber has been substantially declining since April while the wholesale sales presented a V-shape rebound. What is happening in the lumber market in Canada now is similar to the meltblown fabric (main materials used in mask production) market in February and March in China when demand for masks surged and supplies failed to catch up,” noted the team.

As of August 25, the return year-to-date for the commodity has increased to over 100%.

“The increase in lumber price gives Taiga the ability to charge a higher mark-up on products, as well as earn extra gross profits from earlier inventory that was stocked at lower prices,” says the team, who believe the company’s earnings for the FY will be largely driven by Taiga’s 2H20 performance.

“While lumber prices will eventually correct as supply is restored, we see this as a short-term boon for Taiga, who will experience substantial inventory gains on its $130 million or so of inventory as of June 2020. Taiga can also charge a higher mark-up on their goods as lumber is now largely a sellers’ market. 2Q20 results have already displayed such a tendency as Taiga’s gross margins rose to 12%,” it adds

On that, the team also conservatively estimates that 4Q20 will drop 44% q-o-q on the back of a seasonally weak 4Q.

“As a result, we estimate profits after minority interest of at least $41 million for Avarga in FY20F.”

Shares in Avarga closed 9.5 cents higher, or 44.2% at 31 cents, its highest year-to-date.

Tong Kooi Ong, executive chairman of Avarga, is also chairman of The Edge Media Group, the parent company of the publisher of The Edge Singapore. Ian Tong, CEO of Avarga, is also executive director of The Edge Media Group.