UPP Holdings – 5.4x Net Cash P/E
UPP Holdings was founded in 1967 and is headquartered in Singapore. The company operates two business segments: 1) pulp and paper mill and 2) Ywama power plant.
The pulp and paper mill is its core business, but it has been facing poor profitability, with 2013 net margins at 3.1%. The segment is based in Malaysia and produces corrugated carton boxes and brown paper products for Malaysia’s manufacturing sector. As of 9M2015, revenue from the segment accounts for about 80% of total revenue.
Investment Thesis
The value of UPP lies in its power plant business which only commenced operations in February 2014. The company operates a 50MW gas-fired generating plant in Ywama, Myanmar.
Under the Power Purchase Agreement with Myanma Electric Power Enterprise, UPP will sell electrical energy at a rate of US$0.034 per kWH and the guaranteed annual minimum off-take amount is 350 million kWH. That is US$11.9mn, or S$16.7mn based on a 1.4 exchange rate, in annual operating cash flows.
As an operator, UPP does not bear any price/cost risks. Consequently, margins are expected to be high. In 9M2015, the segment generated S$5.8mn in revenue and incurred S$2.1mn in costs, so that’s about 64% in terms of gross margins.
I believe it is fair to expect about S$10.7mn (0.64 x SG$16.7mn) in annual operating cash flows from the segment. 9M2015 operating cash flows for the company is already S$16.1mn.
UPP currently has a market capitalization of S$123.8mn with about SG$46.7mn in cash less all liabilities. Net of cash and all liabilities, investors are paying S$77.1mn for a power business that generates S$10.7mn in cash flows annually. With a rough S$1.0mn in annual capex, this translates to a FCF yield of 12.6%.
We have ignored the valuation of its paper and pulp business entirely. Other basic metrics are as follows:
P/E: 8.7
Dividend yield: 3.4%
EV/EBITDA: 6.4
P/B: 0.7x
UPP has no debt.
Investment Risks
Myanma Electric Power Enterprise is a governmental body of the Republic of the Union of Myanmar. As with most developing economies where the rule of law is weak, political risk is a key investment risk. The government might have insufficient funding, or simply refuse to recognize the contractual terms signed by previous governments. Ultimately, investors have to ask themselves if the 12.6% FCF yield is commensurate with the risks associated with a developing economy.
Shareholder and Management
Mr Tong Kooi Ong heads UPP as the CEO. Mr Tong owns The Edge and has seen numerous business successes with Malaysian companies like PhileoAllied and Sunrise Group. Singapore billionaire, Peter Lim, is also a shareholder of the company. Together, Mr Tong and Mr Lim are the two largest shareholders of the company with a 25% and 22% stake respectively.
Conclusion and Thoughts
Personally, I believe the political risks are lower after the conclusion of the Myanmar elections. The newly-elected Democratic government is also less likely to do something which hurts investors’ and business confidence. Given that power plants are essential infrastructure, the risk of insufficient funding is also low – we will see funding cut from many other areas before it affects power generation. A rising USD also lends further upside since contract payments are denominated in USD. Overall, power generation is a relatively stable business but in UPP’s case, investors have to contend with political risk in place of economic risk.
I think it’s a worthy bet, but what do I know? It would be interesting to hear any thoughts that you may have.
The author is vested.
