Description

With half of its market cap in cash, Taiga Building Products is as cheap as it has ever been and it is hard to imagine losing capital on this bet at current prices. TBL is a Canadian distributor of lumber, panel, treated wood, and other building products. As can be expected, the business was booming over the last two years and the company now sits on a large pile of cash. This could be returned to shareholders in the short term. My investment thesis rests on nominally and historically cheap valuation as well as a fairly consistent earnings profile. An announcement of a large special dividend would be a nice catalyst for the shares to re-rate. 10% special dividend was paid out at the beginning of 2021 and currently Taiga is in an even better financial position to return cash to shareholders.

There are a number of things to like about TBL.

Half of the market cap in net cash. As of Q3 ‘22 the company had C$100m of net cash on the balance sheet with another C$70m+ expected to be released from receivables over the current quarter. Thus, more than half of the market cap (C$280m) will be in net cash by the end of the year. Previously the company had always operated with leverage (mostly credit facilities backed by working capital) and only in the post-pandemic period started showing a net cash position on its balances. Part of this cash will be required for seasonal working capital purposes but a large portion is likely to be pure excess cash that could be easily returned to shareholders or spent on M&A. If TBL started financing its working capital through credit again, then by my rough count the company would have C$200m+ in excess liquidity.

Strong and consistent FCF generation. TBL has delivered rather consistent FCF irrespective of fluctuation in lumber prices. Gross and operating margins have remained very stable through the cycle at around 9-10% and 2.5-3.5% respectively. I am expecting similar profitability levels going forward. During the pandemic period, GMs were boosted to 14% and OMs to 6% - this will likely revert to historical levels during the coming quarters. On a normalized basis, the business should generate around C$30m-C$50m of FCF annually. 2021 was an exception with C$115m in FCF.

Consistent growth in BV/share. 2/3rds of TBL assets are in working capital + cash, with the rest attributed to leased distribution centers (15 in Canada and 3 in US) with an offsetting lease obligation on the liability side. In a way, the net BV of the company is fully comprised of cash and working capital, which is pretty liquid and turns over 5-6x times a year. BV/share has also been growing very steadily over the last 15 years and currently stands at C$3.28 or 25% above the TBL market prices.

TBL is cheap on all metrics. Depending on the excess cash assumptions, Taiga Building trades at an EV of C$100-C$200m. As shown above, this business has generated C$40-60m in FCF pre-covid and there seems to be no reason why normalized earnings should be materially different from these levels. This results in TBL’s operating business trading at 3-4x normalized FCF. The company is also at the cheapest levels it has traded historically with regard to its BV and Revenues. The current discount to BV looks particularly attractive given the large net cash position. Given the liquidity of TBL’s book value and the absence of any other liabilities on the balance sheet, I would say BV/share is the absolute floor for TBL’s valuation.

TBL Price vs BV/share:

And it also trades at a historically low revenue multiple:

Returning cash to shareholders. Despite high FCF generation the company was not rushing to return cash to shareholders - share repurchases have been rather symbolic, amounting to only C$10m during the last 5 years. However, in Feb '21, following a strong 2020 financial performance and reduced leverage, Taiga paid out C$30m (10% of market cap) in a special dividend. This was a game changer for TBL minority investors - or at least it should have been. Given the controlling 72% ownership by its Singaporean parent (Avarga, ticker U09.SI) and limited return of capital to shareholders thus far, this special dividend was proof that the parent will not hoard cash at Taiga level indefinitely, will not siphon it in some other way, and that TBL’s minority owners might actually get to share the fruits of company’s success. 

Unfortunately, the same was not repeated after a bumper 2021 as all the generated profitability got tied up in inventory and receivables during Q1’22 - net working capital of c. C$400m vs C$230m historical levels for the first quarter of the year. Lumber prices were at their peak levels during Q1 ‘22. TBL’s parent Avarga explained the move saying a “prudent approach is to preserve capital to take advantage of opportunities that may arise”. The decision to retain cash internally seems to have paid off handsomely - TBL’s book value has increased from C$267m in Dec’21 to C$355m as of Sep’22, for a 33% value accretion in 9 months.

With the housing boom and lumber prices normalizing towards pre-covid levels, the opportunities to invest the excess cash organically are now more limited. There is a decent chance that a large dividend will be again announced with the annual results in Q1’23. At the time of the Feb’21 dividend payout, the company had a much weaker balance sheet - C$30m of net debt vs my estimated $170m net cash position at the end of 2022 - suggesting that the return of capital might be far larger right now.

Management might also decide to spend the excess cash on M&A, fitting the line of taking “advantage of opportunities that may arise”. Back in 2018 TBL paid C$56m to Exterior Wood, the operator of a wood treatment facility and distribution center in Washington state. It is hard to tell if this acquisition has been accretive or not, as the disclosures are limited and the onset of COVID has complicated YoY comparisons even more.

Valuation

I do not have any particular insights on where TBL should trade, just as noted above, I think 1xBV is the absolute floor for TBL’s valuation. That would put shares at C$3.3 or 25% above current prices. However, that’s the balance sheet liquidation value only. When it comes to the operating part, I think this business is set to generate $30-50m in FCF going forward. That would be a 2.3-3.8% net margin on 2019 revenues - fully in line with results shown historically. At 10x multiple plus C$150m in excess cash, TBL shares would be double from today’s prices.

Comparison to US-listed and far larger comps BXC and BLDR is complicated, as their historical financials are not very relevant due to a high number of large acquisitions, whereas recent financials have been distorted by COVID tailwinds. However, at least on a BV basis TBL clearly stands out as the cheapest among its peers. 

Why does this opportunity exist?

Taiga Building Products is a Canadian micro-cap with only C$20k in average daily trading volume. So it is out of the radar for most. The disclosures in financial statements seem to be at the bare minimum - aside from the longer-term track record, it is hard to draw conclusions on how the business is performing at any point in time. That is further complicated by unexplained material QoQ shifts in gross margins and SG&A expenses (however, these average out when looking from the annual perspective). The company is 72% controlled by a Singapore-listed Avarga, which in itself is controlled by the Tong family. Executives from the family are paid very well from TBL’s coffers. Finally, the business is facing a deteriorating macro environment and a potentially overheated Canadian housebuilding market.  

My thesis is that the above-mentioned risks are more than countered by the currently low valuation, cash-rich balance sheet, historical track record of profitability, precedent of large dividend paid in Feb '21, and a potential for an even bigger payout over the coming few months. As I said at the start of this write-up, the risk of permanent capital loss at current prices seems low, and the upside optionality is high.

Catalyst

Potential dividend in Q1 2023 or another type of capital return to shareholders.

Continued FCF generation.