**After reading hundreds of annual reports, I'd shortlisted about one dozen CEO/Chairman statement which I believe are top notch. Here's the first of the series. For full annual report, go to the link at the bottom. Feel free to comment if you have any good CEO/Chairman statement to share.
Dear Fellow Shareholders,
This is my fifth annual report card to you. I joined your Board on 15 March 2012 and became the Chairman and CEO in May 2012.
Each year, I use this opportunity not just to report on the financial health of your Company and explain the reasons of the financial results, but I also attempt to articulate my vision, values and strategies to the best extent possible. For competitive, legal and regulatory reasons, I am obviously not able to elaborate fully.
I have done the same since the 1990s when I headed numerous public listed companies in Malaysia, Canada and Singapore.
The cover on the annual reports each year tells the story: the challenges, the developments, the achievements, the hope and aspirations.
It started with seeking new business opportunities in 2012, to the frustrations in securing the Myanmar power plant that followed, and then the realisation of the plan and finally the rewards of that achievement.
At the same time, we were able to achieve much higher profitability as the paper manufacturing and recycling business turned more efficient, more productive and was blessed with stronger demand.
With the two core businesses of paper manufacturing and power generation “taking roots” in 2015, we made two major decisions last year, which I articulated in last year’s annual report.
The first was paying a tax-exempt dividend of 1 cent per share last year, and a promise that we will endeavour to continue paying the 1 cent per share dividend annually for each of the next three financial years ending 31 December 2016, 2017 and 2018, barring any unforeseen circumstances.
This is the highest dividend paid in this Company’s history. I also believe it is the first time a Singapore public listed company made such a declaration. It is only possible because we are confident that our core earnings are sustainable.
The second decision was mentioned in the last paragraph of Page 6 of the 2015 Annual Report. We had substantial cash balances. “We are aware that as the custodian of your Company, we have a responsibility to improve the returns on the assets of your Company, including the cash we have built up. If we fail to find good assets to invest in, we should hand the cash back to shareholders.”
We managed to acquire 58.34% of the common shares and C$46 million principal amount of the 14% unsecured subordinated notes of Taiga Building Products Ltd. (“Taiga”) of Canada, on 31 January 2017, following shareholders’ approval at the EGM. The total consideration was C$71.8 million.
I was an interested party, where I also sold my 19.25% stake in the common shares of Taiga to UPP Holdings Limited for C$6.2 million in cash. The Independent Board members recommended this acquisition after having considered the financial effects and that they are not prejudicial to the interests of the Company and its minority shareholders.
If you have not done so, I would encourage you to read the Circular to Shareholders of 16 January 2017 on the proposed acquisition of the Taiga common shares and Notes and the proposed bonus warrants issue.
I feel I should describe a bit more of the business of Taiga later in this Statement, given the recent successful acquisition. A financial discussion will be more fully articulated in next year’s annual report when we consolidate the financial results of Taiga into UPP Holdings.
In any case, Taiga is a public listed company on the Toronto Stock Exchange. Shareholders of UPP Holdings are encouraged to look up on Taiga’s past performances, its business model and its successes and failures. As in the case of UPP Holdings, my Chairman Statements in the annual reports of Taiga are also fairly frank and descriptive. And I was the CEO of Taiga for almost four years from 2005.
Building Value
This leads me to the theme for this year’s Annual Report, BUILDING VALUE.
I believe the cover for this year’s annual report fairly reflects the story of UPP Holdings so far.
What is “Building Value” for your Company?
Perhaps a quote from Warren Buffet helps explain. “Price is what you pay. Value is what you get.” And what you get is the discounted anticipated future cash flows.
It is our responsibility to maximise what you can get out of the Company as a shareholder, in terms of dividends and capital gains over the long term. The best way to achieve this is to continuously improve on the profitability of existing businesses, to invest into new ventures that generate good returns taking into consideration acceptable risks, to manage the level of borrowings to maximise Return On Equity (“ROE”) without sacrificing our balance sheet strength, and to align the interest of staff and management with shareholders.
The starting point to building value and enhancing profitability is always about people, rather than the types of businesses, the countries they operate in or whether they are perceived to be sunset or sunrise industries. Human make things happen, constructively or destructively. We are capable of coming out with ideas and technologies that can creatively disrupt or creatively collaborate.
For us, it starts with our core values and beliefs. We also know our own strengths and weaknesses, arising from our experiences and the expertise we have gained over time. We are realistic to venture into businesses where we believe we have competitive advantages, and only after we have articulated what we believe is a sustainable business model.
One of our core strengths is the ability to analyse and develop business models. We are factual, analytical and meticulous. As a result, we are not easily swayed by trends, fads and exuberances. This requires a disciplined approach with a long term horizon.
Critically, businesses work best when interests are aligned, whether it is with suppliers or customers or with staff and management. Many companies provide stock options and performance bonuses based on achieving Key Performance Indicators (“KPIs”) and profit targets. Instead of creating value for the company, it sometimes encourages short term opportunistic behaviour and high risk taking. Giving someone an option on the upside without an equivalent downside cost is irrational. And most KPIs are only focused on short term targets, and therefore not holistic and comprehensive enough to encourage decisions that promote long term sustainable profitability and value.
Wholesale Distribution of Building Materials in Canada and USA
With both the paper and power plants running at full capacity and reaching their limits in terms of profitability, we needed a third leg to continue growing your Company.
The acquisition of Taiga Building Products provides UPP Holdings a new platform to grow.
Established in 1973 and listed on the Toronto Stock Exchange 20 years later, 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 and 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 also exports to Pacific Rim countries, Central and South America, the Middle East and Europe from its head office in Burnaby, British Columbia, Canada.
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, but also from Asia and Central and South America.
Customers of Taiga range from the very large retailers and DIYs 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.
Its products are mostly used for new residential landed residences and for renovations.
Taiga employs over 400 employees. Annual sales is over C$1 billion with a gross margin in excess of C$100 million.
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. This is made possible by the product mix of its sales, its wide and huge distribution capabilities, and the high level of efficiencies.
Another critical aspect is the alignment of staff and management with shareholders. Introduced in 2005 when I was the CEO of the company, Taiga has a unique Pay for Performance (P4P) structure that incentivise management and staff to maximise the profitability of the company over the longer term, right down to the forklift operators and office clerks. For trading businesses, it is important that sales people do not give away inventory profits or make low margin sales. And percentage gross margins are low, so operating and cost efficiencies are paramount.
I would like to discuss Taiga’s business model as a wholesale distributor, from a strategic and macro industry analysis perspective. I will reserve all discussions on the financials of Taiga to next year’s annual report.
There are a lot of academic papers and consultant reports on the end of wholesale distribution as a business model. How producers will bypass wholesalers to sell direct to the retail outlets. And more recently, how producers will bypass retailers to sell direct to customers, or often abbreviated as B2C.
Innovation and change (whether technologically driven or not, but almost always enabled) is a given fact which usually improve conveniences, costs and profits. Digitalisation of the world, the democratisation of assets, people and economies; and the effects of mass customisation and localisation of production will only accelerate.
But there is also the risk that it may lead to generalisation, simplification of analysis and misleading conclusions. Putting together a theory or getting to a useful general conclusion sometimes result in us ignoring inconvenient facts, removing “outliers” in data or making unrealistic assumptions due to lack of knowledge and expertise. To quote George Bernard Shaw, “Beware of false knowledge; it is more dangerous than ignorance.”
Canada is a country with the second largest land mass in the world, totalling nearly 10 million sq km. It has a fairly small population of just 35.9 million people, giving it a population density of 3.6 people per sq km. The US has a land area just slightly smaller than Canada at 9.8 million sq km, but it has a population of 321.4 million people, or a population density of 32.7. Singapore has a land mass of 717 sq km and a population of 5.5 million, or a population density of 7,719 people per sq km.
The economic geography of these countries will result in different business models, especially when the distribution and handling costs are high relative to the selling prices of these products, such as the case for building materials.
And it gets a lot more complicated. There are thousands of items required to build a new home or when undertaking renovations. The volume required for each product differs from one another. Customers need the complete range to be delivered on time and to the right place, as and when required. And customers range from individual DIYs to contractors and large scale builders. The gross margins for these products ranges from as little as 3-4% to as high as plus 20%, often a function of volume.
I expect few people can fully comprehend, but I hope I am able to show that Taiga has a sustainable business model that is unique.
Next 12 months
The acquisition of Taiga has used up all our available cash resources and more. We have secured new banking lines. And since interest costs are substantially lower than the ROE we are able to achieve, this leveraging is value-accretive. I believe we have more room to leverage up as our underlying assets are able to generate sustainable cash flows.
But we will be cautious and not sacrifice the strength of our balance sheet. We have always and will continue to be judicious in our investments, with a careful analysis of not just returns, but also risks.
There are still many opportunities, including in the industries we currently operate in.
There are also clear capital market inefficiencies. The huge growth in Exchange Traded Funds and Private Equity generate new opportunities. The trend to Beta investing and funds pouring into private markets, especially new technology start-ups, is a gift to value investors.
Case in point. Last year, we took an opportunity and bought a 4.98% stake in the ordinary shares of Classic Scenic Berhad at a total consideration of RM8.52 million, or RM1.42 per share.
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.
We bought the shares at RM1.42 each and have since received 6 sen in interim dividends. The stock price as at 20 February 2017 was RM1.99, giving us a total gain of 44.4% in well under a year, including the dividend.
We are not traders and will not become stock traders. We take strategic interests when an opportunity presents itself.
Acknowledgement
As mentioned earlier, the management and staff did a commendable job last year. Not just in securing the new investments but also in improving the efficiencies of our current businesses. The team that completed the Taiga deal worked very hard at it. And this includes our advisors, especially the lawyers from Chang See Hiang & Partners. Internally, Tai Lai Yeen, our Group Finance Manager, deserves much credit.
The Board and especially the independent directors played a pivotal role, in sharing their wisdom, advice and decisions in the acquisition process. Since last year, the Board has also approved a performance bonus that is based not only on profits, but also takes into consideration the risk and the required rate of returns on our investments. This will further align staff and management interests to your interests as shareholders.
And to you as shareholders, I hope you are enjoying the journey so far and I hope you will stay with us in the journey ahead. There will be bumps no doubt. The road ahead is never smooth or easy. But I do think the tree we have planted has taken roots.
God Bless and thank you,
TONG KOOI ONG
Chairman of the Board and CEO
Link: http://infopub.sgx.com/FileOpen/UPP_AnnualReport2016.ashx?App=Announcement&FileID=446352
