On 07/05/14, I purchased Riverstone Holdings at a cost of $0.875. Similar to Kingsmen Creatives, I had been waiting for the stock’s price to become more attractive before sowing, but the price ran up instead. I was expecting the stock to go down in price after giving ex-dividend, but due to a favorable earnings release, it shot up instead. Currently, the stock price has gone down a little to $0.855, which serves as a lesson to me to let the waters calm first before going in.
Riverstone Holdings has a simple business model. It manufactures gloves for the cleanroom and healthcare industries. It exports its products to countries across the world. In the cleanroom industry, it is the market leader (~60%), with HDD stalwarts like Seagate, Western Digital, Hitachi, Toshiba, and TDK as clients. This area provides the highest margins, as cleanroom gloves tend to be around 2.5-3 times more expensive than healthcare gloves. The company has also entered into the lower end cleanroom industry by targeting the panel and tablet market. This area, which currently represents ~20% of total cleanroom gloves, has the same margins as the high end cleanroom gloves, but a lower selling price. The company mostly sells direct to its customers. For the healthcare segment, the company has entered the industry in 2009, and currently sells to distributors who relay the customisation of the end customers’ needs, eg. hospitals. The production breakdown is currently 69% healthcare, and 31% cleanroom, but the revenue contribution is 49% healthcare and 51% cleanroom. Due to the relatively higher margins cleanroom gloves command, the gross profit is weighed 70-30 in favour of cleanroom gloves.
The company is targeting 8 billion pieces in FY19, and wants to grow production by 25% each year. Lower margins is expected going forward due to the expansion into the medical sector. The HDD industry has remained flat, and most of the growth in the cleanroom division has been driven by the mobile segment. I think one key question here is whether the demand is able to absorb the supply coming onboard? The big 4 players in Malaysia, namely Hartalega, Top Glove, Supermax, and Kossan have stated their intent to grow their production capacity. Hartalega aims to grow its capacity to 28 billion by 2020. Nitrile gloves demand is expected to grow by 20% yearly for the next 2 years moving forward while healthcare gloves demand is currently estimated to be more than 155 billion pieces. Perhaps the more pertinent outlook would be the penetration of nitrile gloves in the world. Currently, the US and EU have 148 and 98 per capita glove usage (pieces) whereas China and Asia have a per capita glove usage of 4.6 and 4.8 pieces. If demand in China picks up to the level of the EU, total demand for gloves from China alone would be 132 billion. There remains opportunity for industry expansion in Asia, especially from China and India. The growth in demand for nitrile gloves has also been attributed to the decrease in demand for latex gloves as nitrile gloves are seen as stronger and have lower allergy issues. However, nitrile gloves tend to be more expensive, and this is why growth of nitrile gloves has largely come from developed markets. Nevertheless, a good thing about the gloves industry is that gloves are fast moving and a consumable. Due to its low cost, people do not usually wear the same gloves throughout the day due to the risk of contamination. For example, a doctor does not wear the same gloves when inspecting two patients as germs may be spread between the two through the gloves. Moreover, in the cleanroom industry, contamination is regarded seriously, and customers would not want to risk the quality of their goods just to save a few cents. In this regard, the company’s healthcare gloves segment marked an impressive growth of 30% in 2013.
Key risks for this investment are the depreciation of the USD/MYR exchange rate. Although there is some form of natural hedge as raw materials and products are both purchased and sold in USD, other factors like labour are usually paid in their domestic currency. Management has attributed the strong performance in recent quarters due to a favourable exchange rate and lower raw material costs. That being said, we cannot expect raw material costs like nitrile which is linked to crude oil to remain low. In fact, I do not think crude oil is currently low, but it is relatively stable. However, the latex prices are very low at the moment, something which I do not foresee staying for long. Considering that raw materials makes up 25-30% of total costs, this is significant. The last key risk for this investment is the oversupply of gloves in the industry leading to pricing competition and low utilisation of plants. In fact, CIMB has released a report recently, downgrading the gloves sector as it believes the overproduction would lead to fierce competition between glove players, resulting in lower ASPs.
The risks for this investment are real. Raw material prices will not stay low for long, and it will rise again due to the cyclical nature of the commodities market. However, I think a rise in raw material costs can be partly transferred to the customers due to a pricing agreement between the manufacturers and customers. As for forex risks, I believe that the USD will continue to appreciate against the MYR as its economy recovers and because of strong fundamentals of the country. Pricing pressures will undoubtedly affect Riverstone, but I think it will be be partly muted as the company is a niche player and does not want to be engaged in the price war among the mass producers. An example of niches the company targets would be the HDD industry, the mobile industry, and premium healthcare gloves. In all these markets, the company looks at customisation for each customer as opposed to mainly mass producing.
The company is currently expanding, and is building a plant in Taiping, Perak. Expected production is estimated to be 4.2 billion by Dec 2014. The plant is situated on a 30 acres land, while current plants only occupy 22 acres. Total cost is estimated to be around RM 400 million, in which the first two phases of RM 80 million and RM 40 million is estimated to be funded through internal resources. The next 2 phases are likely to be funded through bank borrowings. Additional production per phase of 1 billion gloves is estimated.
*Taken from 2013 Annual Report
If we take a look at the 5 year financials, the company has seen revenues and earnings almost increase every year from 2009 to 2013, as gloves production increased from 1.1 billion to 3.1 billion. From the table above, we see that margins were the lowest in 2012. This was due to reduced ASPs for its gloves because of increased production by competition and a lacklustre HDD market. Taking the same margins, and using a conservative back of the hand forecasted revenue of FY15 RM480 million derived from a target of 3.57 billion gloves (utilisation rate of 85% and a capacity of 4.2 billion in FY15, 2.635 billion gloves from a utilisation rate of 85% and a capacity of 3.1 billion in 2013), I arrived at a net profit of FY15 RM60 million. This is a low ball figure as I used a fair utilisation rate, a low net margin and a low capacity as capacity should be higher in FY15 due to the different phases of development. For Riverstone to show such earnings in FY15 would indicate low or minimal growth in earnings. If that is the case, would its PE then drop, resulting to a drop in its share price? The current PE at my purchase price is 14, and FY12 historical PE was at 8.65. Using FY12’s PE, we would arrive at a share price of around $0.55, giving a downside of 37%. On the other hand, assuming a utilisation rate of 90%, capacity of 4.7 billion in FY15, net profit margin of 16.2%, and a PE of 14, we would arrive at a share price of $1.37, representing an upside of 56.6%. The question now is, which case is more likely to happen? I believe that production and utilisation will remain strong as the demand for its goods is there. The HDD industry is forecasted to pickup from now till 2017, according to research reports. As for the forex and raw material costs, this should be slightly offset by pricing agreements in place and improved manufacturing efficiency when more lines are produced. The key battle would be the ASPs of its products, in which Riverstone needs to pick its battles carefully to avoid price wars. One has to keep in mind the net profit margin in the next few quarters.
Management owns most of the company (~60%), with the two top shareholders being the two founders. Compensation plans for these two are geared towards profit sharing plans (74%), as compared to mainly salaries (26%). Dividends have been growing strongly each year from 2006 to 2013, and dividend payout is in the range of 45-50%.
At my purchase price of $0.875, the company was trading at a PE of 14 based on FY13 earnings. Its ROE in 2013 is 18.0%. It is currently net cash, with cash buffers of RM108.9 million as of 1QFY14. This is expected to drop due to capital expenditures for its Taiping plant. Compared to the average of its peers, it is trading at a lower PE and PB ratio with a higher dividend yield. The strongest competitor would be Hartalega which is the world’s largest nitrile gloves producer with a ROE of around 30%. However, most of its competitors are players in the healthcare segment and are expected to compete aggressively moving forward. Dividend yield of Riverstone Holdings, at my purchase price is around 3%.
In conclusion, after weighing the risks, I feel the visibility of earnings for the company is strong, the management has a track record of growing revenues, earnings and paying dividends, and its conservative strategy of choosing its battles appeals to me.
Disclaimer: The author owns shares in the abovementioned company. The ideas expressed in this blog should not be construed as an enticement to buy or sell the securities, commodities or assets mentioned. The accuracy or completeness of the information provided cannot be guaranteed. Readers should carry out independent verification of information provided. No warranty whatsoever is given and no liability whatsoever is accepted for any loss howsoever arising whether directly or indirectly as a result of actions taken based on ideas and information found in this blog.