Riverstone Holdings - DBS Research 2018-02-26: Lifted By The Semiconductor Upcycle

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RIVERSTONE HOLDINGS LIMITED AP4.SI

Riverstone Holdings - Lifted By The Semiconductor Upcycle

• Riverstone delivers record earnings in FY17 despite unfavourable forex; headline profits up 7.4% y-o-y to RM129.3m.
• Core earnings outpaced output growth slightly (+17.1% vs 16.9% y-o-y), implying its strategy to grow the higher margin cleanroom segment is paying off.
• Riverstone can outperform peers amid industry headwinds as it ramps up on cleanroom glove capacity. 
• Upgrade to BUY with a higher Target Price of S$1.27.

Upgrade to BUY with Target Price of S$1.27 as we see earnings growing on strong cleanroom ramp-up. 

• A global market leader in niche Class 10 and Class 100 cleanroom gloves, Riverstone’s edge in the high-tech cleanroom segment sets it apart from the bigger boys. Given intense competition in the healthcare space, we see value in Riverstone’s growing cleanroom business – which allows the group to command consistently higher margins vs peers (16% vs peers’ c.10-15% in FY17).
• With new cleanroom facilities set to kick in from 2Q18, cleanroom capacity is expected to grow by c.33% to at least 2bn gloves p.a. The ramp-up on these new capacities should help drive higher growth in cleanroom gloves vis-à-vis the lower-margin healthcare business, allowing Riverstone’s earnings growth of c.16% to catch up with larger peers’ c.17%.

Where We Differ:

• We are more bullish vs consensus as we expect the improved output mix to help sustain margins and drive bottom line.

Potential Catalysts:

• Further capacity expansion, sustained increase in cleanroom glove mix (and thus margins), and inorganic growth.

Capacity expansion and improving mix to underpin long-term growth.

• In anticipation of strong demand for both its cleanroom and healthcare gloves, Riverstone is now in the process of accelerating its expansion plans. Under its revised three-year expansion plan, we expect total glove production capacity to grow to 9bn pieces by end-2018 (vs 8.2bn previously) and 10.4bn pieces p.a. by end-2019.
• Backed by robust demand and expectations of a higher cleanroom mix, we project earnings to grow at a c.16% CAGR from RM129m in FY17 to RM173m by FY19F.

Valuation

Upgrade to BUY with Target Price of S$1.27, based on 16x FY19F PE.

• Underpinned by double-digit capacity growth and higher-quality earnings growth supported by more stable cleanroom margins, we believe that Riverstone deserves to at least trade at its historical average valuation of 16x FY19F PE, which represents a c.45% discount to larger peers’ 29x.

Key Risks to Our View

Global economic slowdown. 

• While margins for cleanroom gloves tend to be resilient, demand for these gloves could be threatened in the event of a slowdown in the global economy.

WHAT’S NEW - Riverstone rises above persistent headwinds to deliver record-breaking FY17 

Record RM129.3m profit in FY17. 

• Riverstone delivered a decent set of 4Q17 results despite challenging operating conditions. Sales grew 12.2% q-o-q to c.RM210.7m on the back of capacity growth, but the unfavourable mix shift towards a higher proportion of lower-margin healthcare gloves resulted in relatively flat earnings of c.RM34.2m (vs RM34.3m in 3Q17).
• On a full-year basis, the record sales and earnings of RM817.4m and RM129.3m were largely in line. 
• Higher dividend of 7 Scts for FY17 as Riverstone maintains a 40% payout, up 8% from 6.49 Scts in FY16.

Forex volatility a drag on strong core growth momentum.

• Volatility in the USD/MYR rate has weighed heavily on the sector’s performance, Riverstone was not spared. In FY17, the group incurred net foreign exchange losses of c.RM13m, partly offset by hedging gains of c.RM6.8m as the company typically hedges c.50% of contracted sales.
• Apart from the forex drag, Riverstone’s core growth was otherwise strong, growing c.17.1% y-o-y to c.RM135.5m (vs c.RM115.8m in FY16): Plans to further cultivate cleanroom business starting to pay off. Taking into account Riverstone’s temporary operational hiccup in 3Q which affected its production ramp, we observe that core earnings momentum has in fact outpaced output growth at 17.1% vs 16.9% respectively, implying that plans to further grow cleanroom sales are starting to bear fruit.
• While dipping lines can be used interchangeably between healthcare and cleanroom gloves, the latter typically undergo additional secondary processes in specialised cleanroom facilities. Discussions during the 3Q17 and 4Q17 results briefing revealed that utilisation for these facilities have improved by > 20% q-o-q to nearly 100% currently, which further supports our view that the cleanroom segment is starting to see stronger growth vs the healthcare segment.

Anticipate weaker 1Q18 as headwinds persist, but stronger growth to kick in from 2Q18. 

• With operating conditions little changed, we expect industry headwinds – fluctuations in USD/MYR, volatile raw material prices and operating costs – to remain a bane for the glove industry at large. Further, with the revised foreign worker levy policy and gas price hike coming into force in January 2018, we anticipate 1Q18 results to be weak across the industry.
• All else equal, underpinned by a c.33% increase in cleanroom capacity to at least 2bn by end-2Q18, Riverstone is set to see stronger growth ahead. Full contribution from these incoming cleanroom capacities will likely only come in from FY19 as the group ramps up on production progressively.

Riverstone due for a re-rating. 

• While shares of larger peers – Kossan, Hartalega and Top Glove have re-rated strongly in recent months, Riverstone’s strengths remain under-appreciated. Based on consensus estimates, Hartalega currently trades at +1SD of its historical forward PE valuations, Top Glove and Kossan above +2SD. 
• Meanwhile, Riverstone continues to trade below its historical average forward PE. As a result, Riverstone’s discount gap has widened significantly vs peers, from c.28% to 49% currently.
• Underpinned by capacity growth at c.17% CAGR (vs larger peers’ average of c.15.2%) over FY17-19 and higher-quality earnings growth supported by more defensible margins, we believe that Riverstone deserves to at least trade at its historical average valuation of 16x FY19F PE (c.45% discount to larger peers’ 29x) as earnings growth catches up. 
• Better-than-expected execution on these incoming capacities could spark a further re-rating to 18x FY19F PE (+1SD), in line with peers.

Upgrade to BUY with a higher Target Price of S$1.27, based on 16x FY19F PE. 

• Post 4Q17, we assume higher margins on a more favourable product mix, and partly offset by lower ASPs resulting from the recent forex weakness, we raise our FY19F earnings projections by c.6% to RM172.8m.
• After rolling forward our earnings base to FY19F to better capture the strong growth potential from the roll-out of incoming cleanroom capacities, and pegging to historical average forward valuation of 16x, we arrive at a higher Target Price of S$1.27 (vs S$1.09 previously). 
• Upgrade to BUY.

Carmen TAY DBS Vickers | http://www.dbsvickers.com/ 2018-02-26

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