On the back of a strong growth since 2013, Riverstone Holdings Limited is faced with a speed bump recently as 2019 proved to be a challenging year for the company. Share price of Riverstone Holdings peaked at $1.20 per share in late 2018 and has since plummeted to a recent low of $0.90 per share in Q2 this year. The Group’s strong financial performance was dragged down by weaker margins due to higher operational cost and strong competition in its healthcare gloves business.

Despite the short-term weakness, the stock is still a good long-term investment as the company plans to continue its expansion. In this article, we will discuss some investment merits that Riverstone presents and consider the key catalysts that will power Riverstone to the next phase of growth.

Key Takeaways from Q3FY19 Results

After a weak Q1 result, Riverstone’s Q3FY19 results reported gradual improvement in margins and rising orders due to production optimisation and a shift in product mix. As its raw material, butadiene prices remain steady in recent months, the Group should expect further improvement in margins as raw material costs stabilized. If operating environment remains steady, the Group will add an additional capacity up to 1.4 billion pieces of gloves by 1Q2020 for Phase 6 of its expansion plans, which will bring the Group’s total annual production capacity to 10.4 billion pieces of gloves.

What is Riverstone Holdings?

Riverstone Holdings is a leading supplier of cleanroom and healthcare gloves. It manufactures and sells specialised cleanroom and healthcare products often used in highly controlled and critical environments. The Group caters to demand from Hard-Disk Drive (HDD) manufacturers, high-tech electronics industries that manufacture products such as mobile phones, tablets, lenses and sensors. Its customers in the electronics industry includes multinational companies such as SAE Group, Hitachi Global Storage Technologies Group, Western Digital and Seagate Technology Group. On the other hand, recession proof industries such as healthcare customers from pharmaceuticals, hospitals and clinics, are stable recurring sources of revenue. 

The group specialises in the production of nitrile and natural rubber gloves and it also manufactures other cleanroom products such as packaging materials and finger cots. In addition, the sale of other cleanroom consumable products such as face masks, face pouches, hoods, caps, jumpsuits, shoe covers, boots, critical task wipes and swabs also contributes to group revenue.

As one of the few integrated manufacturers of cleanroom gloves in Asia, Riverstone operates manufacturing facilities in Malaysia, Thailand and China, and has consistently maintained a utilisation rate of 90%. These facilities contribute to the Group’s total production capacity of 9 billion pieces of gloves in FY18. The Group is now on track to raise capacity by 1.4 billion to a total of 10.4 billion pieces by end-2019. The Group is looking to expand further beyond FY19, with a view to acquire 14.6 acres of land in Taiping, Malaysia.

Competitive Advantage

Glover makers are generally perceived as defensive businesses as it benefits from recurring flow of revenue from its customer base. End users of these products, in healthcare or cleanroom, tend to be sticky customers as gloves are consumable essentials of their daily business operations and does not carry a significant cost on operating expenses.

Riverstone Holdings has a 60% market share in the cleanroom industry which is a competitive advantage against competitors. Despite only accounting for 20-30% of sales volume, the segment contributed more than half of the Group’s net profit due to its ability to command higher margins. Riverstone’s strong competitive advantage in the cleanroom industry is largely attributed to its constant innovation to cater to customer’s needs. For example, in the cleanroom industry, customers were concerned about contamination, electrostatic discharge (ESD), corrosion and particle control. Thus, through various partnerships and R&D, Riverstone were able to develop solutions to meet the needs of its customers.

Potential Catalyst

Although Riverstone is facing short-term challenges such as labour cost and competition. We believe the long-term prospects of the business remains positive. The main driver of growth for Riverstone will be its cleanroom business due to its competitive advantages in the area and its ability to command higher margins.

The Malaysian Rubber Glove Manufacturers Association believe that global demand for gloves remains upbeat. By end-2019, it was estimated that demand would reach 300 billion gloves and with an expected annual growth of 12 per cent. In the long run, demand for nitrile gloves is expected to surpass natural rubber gloves due to rising awareness about latex allergies in emerging economies and nitrile’s low cost.

The Management

Riverstone is currently led by Wong Teek Son who currently owns 50.65% of the company through Ringlet Investments Ltd. He is also Riverstone’s founder, Executive Chairman, and Chief Executive Officer. Lee Wai Keong, its Chief Operating Officer and Executive Director, owns 10.89%. In aggregate, these two key management executives own 61.54% of the company.

Historical data have shown that founder-led business tend to outperform its peers. This is due to several factors such as owner’s mentality, strong corporate culture and skin in the game. Research by Schroders also highlights that founder-led companies invest more aggressively than their peers in research and development (R&D), capital expenditure (capex), and mergers and acquisitions (M&A).

Peer Analysis

Here, we look at Riverstone’s peers within the rubber glove making industry. There are mainly 3 peers that we can compare to understand Riverstone’s operating efficiency. They are:

Although these companies are leading rubber glove makers in Asia, each of these companies caters to a unique set of customer base.

As we know, Riverstone’s competitive advantage lies in cleanroom industries such as HDD and Semiconductors. Top Glove’s products are utilized in many end markets such as aerospace, food, beauty, medical, and home care. Hartalega Holdings caters to the medical industry while Kossan Rubber Industries caters to a diversified product base across technical rubber, gloves and cleanroom. In the following, we aim to compare the profitability and operational efficiency of Riverstone Holdings against its peers.

Profitability

First, we compare the profitability of Riverstone Holdings against its peers. operating and net margins of these companies. From 2014-2016, Riverstone’s operating margins were well above 20% however in the past 2 years, operating margins have dipped below 20% mark. This is largely due to the increasing operating cost in China and Malaysia as labour costs continue to increase. That said, the Group continues to invest in automation to reduce the need for manual labour. As of now, 40% of its healthcare gloves are directly packed after being stripped from the mould.  

Among its peers, Riverstone ranks 2nd highest on operating margin just behind Hartalega Holdings. Hartalega Holdings is currently the largest nitrile glove producer in the world, thus enjoying economies of scale.

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Operational Efficiency

To account for the company’s use of debt, we compare them by its Return on Invested Capital (ROIC) to show how efficient the management team is at using its capital to generate earnings. The last 5 years, Riverstone Holdings have averaged 22.58% return on invested capital. In comparison, Top Glove averaged 13.59%, Hartalega Holdings averaged 19.76%, while Kossan Industries averaged 15.09%.

This is proving that Riverstone’s management team are efficient allocators of capital. The Group has managed to maintain its debt-free reputation in the last five years, at the same time, funding its expansion plans from phase 1 to phase 6 without incurring debt or issuing shares.

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Next, we consider the Cash Conversion Cycle (CCC) of the company to measure how efficient working capital is managed. The metric measures how long each dollar of invested capital is tied up in the production and sales process before it gets converted into cash received. The shorter the CCC, the better the company is at converting inventories and receivables to cash. In the last five years, Riverstone Holdings averaged 58.5 days, it has the second shortest CCC just behind Top Glove which averaged 57.6 days. In comparison, Hartalega took an average of 75.4 days to convert its inventories into cash received. Despite its size and production capacity, Hartalega are not as efficient as Riverstone and Top Glove at managing its working capital.

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Lastly, we analyse Riverstone’s management of inventories and compare it against peers. The Inventory Turnover ratio measures how many times a company sold and replaced its inventories over the financial year. A growing turnover ratio implies strong sales, and vice versa. As you can see, Riverstone’s turnover ratio is growing year on year which implies a strong demand for its products. On the other hand, Hartalega’s inventory ratio seems to decline in the past few years. 

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Valuation

Driven by steady demand from healthcare and electronics sector, the glove manufacturing industry will grow in the next few years. Given its competitive advantage, Riverstone should benefit from rising demand as well as the growing popularity of nitrile gloves. With that, we expect earnings to grow in line with expectations.

In comparison to its peers, Riverstone is a laggard with 16.5x PE (Hartalega 43x PE, Top Glove 32x PE). In terms of price to book value, Riverstone is also a laggard in comparison to peers. The stock now trades at 2.8x PB, while Hartalega is at 7.5x and Top Glove at 4.6x.

Growth expectations are priced in both Hartalega and Top Glove, while Riverstone remains relatively undervalued. Given its dominant market share in the cleanroom business, the market seems to overlook Riverstone’s prospects. If Riverstone’s margins can recover to historical average, it is prudent to expect both PE expansion and share price increase for Riverstone Holdings.

VIA Verdict

As we have analysed earlier, Riverstone management team are efficient capital allocators as shown by its better than average ROIC. Also, considering that the Group has no little to no debt incurred to fund its expansion plans, Riverstone is certainly a bargain.

The business has a good track record of delivering growth for shareholders and are on track to continue with its growth plans. Despite the strong competition from larger glove makers like Hartalega, the Group has managed to maintain its dominance in the cleanroom business. In addition, the segment is expected to be the main driver of growth in the coming years due to higher margins and its strong market share. So, if you’re hunting for a value-growth stock, Riverstone Holdings should be on your radar.

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