Riverstone Holdings - CGS-CIMB Research 2018-08-17: Key Takeaways From Kuala Lumpur NDR

Riverstone Holdings - CGS-CIMB Research 2018-08-17: Key Takeaways From Kuala Lumpur Ndr RIVERSTONE HOLDINGS LIMITED SGX:AP4

Riverstone Holdings - Key Takeaways From Kuala Lumpur Ndr

  • We hosted a non-deal roadshow (NDR) for Riverstone Holdings (RSTON) in Kuala Lumpur (KL), where we saw investors displaying a keen interest in the company.
  • Highlights include the competitive strengths that have kept the company as the leader in the premium cleanroom gloves segment and ability to pass on costs.
  • Riverstone is on track to expand annual glove capacity by 18% to 9.0bn by end-FY19F.
  • We view Riverstone as a laggard play, as it is now trading at a 30% discount to Malaysian peers’ (ex-Hartalega) CY19F P/E average of 20.5x.
  • Maintain ADD with a slightly higher Target Price of S$1.30.

Robust demand growth outlook affirmed

  • We hosted an NDR for Riverstone in KL on 13 Aug 2018, during which investors displayed a keen interest in the company. We stay positive on its earnings growth outlook as Riverstone is on track to raise annual production capacity by 18% to 9.0bn gloves by end-FY18F and subsequently, to 10.4bn by end-FY19F. 
  • Utilisation remains at optimal 90% and is likely to be sustained with the capacity expansion, prompted by huge order backlog and robust demand growth outlook for its cleanroom and healthcare gloves.

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Key differentiator is its premium cleanroom gloves

  • Riverstone believes it has 55% of the global market share for customised cleanroom gloves (Class 10 & 100), counting Ansell and Kimberly-Clark as its closest competitors. The segment accounts for c.20% of volume output in 2Q18 but contributed over half of Riverstone’s net profit due to its ability to command higher margins for cleanroom gloves. Its key markets are Asia Pacific countries, where Riverstone sells directly to customers that mainly deal with smartphone lenses, car sensors and batteries.

Expect strong sales growth for healthcare gloves

  • The segment registered over 10% y-o-y gain in shipment volume and accounted for 80% of total glove output in 2Q18. Key markets are the US and Europe, where Riverstone’s gloves are mainly used as examination gloves in healthcare. 
  • Management is optimistic that the strong demand for its healthcare gloves would be sustained in light of continued growth in global glove demand and rising customer trust in quality of Riverstone’s gloves.

On track to expand capacity by 18% in 2H18

  • Commissioning of new production lines began this month under Phase 5 expansion of its Taiping facility, which will see Riverstone’s annual glove capacity expand from 7.6bn at end- FY17 to 9.0bn by end-FY18F. Construction of Phase 6 has commenced. 
  • According to the company, Phase 6 will lift its annual capacity to 10.4bn gloves. Riverstone’s robust balance sheet (RM70.5m net cash at end-Jun 2018) will support further capacity expansion.

Laggard play compared to peers

  • We view Riverstone’s current 14.3x FY19F P/E as undemanding, representing over 30% discount to its Malaysian peers’ average (ex-Hartalega) of 20.5x. Given the accelerated core EPS growth of 13.1-16.5% in FY18-19F (based on our estimates) on stabilising margins and capacity expansion, we think Riverstone is relatively cheap.

Maintain ADD with a slightly higher Target Price of S$1.30

  • We adjust our FY18-20F EPS forecasts up by 1.7% in view of the strengthening US$/RM. Hence, our Target Price is raised to S$1.30, based on 16.7x FY19F P/E (multiple unchanged) representing c.19% discount to its Malaysian peers’ average (excluding Hartalega) of 20.5x. 
  • Maintain ADD. We estimate the stock offers FY18F dividend yield of 2.4% based on DPS of 7.9 sen (40% payout). 
  • Potential catalysts are higher margins and earnings growth. 
  • A key risk is increase in raw material costs.

Robust demand growth outlook affirmed

Sustainable competitive advantages in cleanroom gloves

  • A common question that investors asked was how it is no other competitors could effectively invade Riverstone’s stronghold in the cleanroom gloves segment. The answer is Riverstone’s ability to produce customised gloves with relatively superior electrostatic discharge (ESD) properties and its constant innovation to cater to customers’ changing requirements. This allows Riverstone to sustain consistently-higher margins for its cleanroom gloves, compared to its lower-margin healthcare gloves.

Optimistic on Malaysia gaining global glove market share

  • Riverstone believes that Malaysia offers an optimal environment for producing gloves due to the fairly low fuel costs and tropical climate that results in consistent temperature. Thus it is optimistic of Malaysia gaining global glove market share moving forward. 
  • In our view, Riverstone could also benefit from the trade war between the US and China, given the 10% trade tariffs imposed on China-made medical gloves, effectively lessening competition from Chinese glove makers in the US market (c.19% of RSTON’s FY17 revenue).

Cost pass-through mechanism in place to limit downside risk

  • Management shared that the company is able to pass on the bulk of cost increases to customers, albeit with some delay between the rise in raw material price and its ASP hike. Riverstone adjusts the prices of its healthcare gloves every 1-2 months, whereas its cleanroom glove prices are stickier, with semi-annual adjustments. 
  • Given the outlook of raw material costs stabilising in 2H18F, management is confident that Riverstone would sustain its current profit margins.

Favourable US$/RM rate could provide earnings upside

  • Favourable US$/RM rates would also be beneficial to Riverstone as the bulk of its glove sales are denominated in US dollar. Based on historical sensitivity analysis by the company, it estimates a 1% strengthening in the US$/RM rate would lead to a 0.8-1.1% gain in net profit. 
  • We note that Riverstone hedges c.50% of its sales and purchases denominated in US dollar to mitigate the foreign currency risk.

Plans for capacity expansion after FY19F

  • Management shared that its Taiping facility, where utility cost is cheaper than its factories in other Malaysian states, still has room to expand, allowing Riverstone’s annual capacity to expand above 10.4bn gloves beyond FY19F. Historically, Riverstone’s production capacity has expanded by 25.6% CAGR in 2007-17.

Preference for higher-value cleanroom gloves

  • Riverstone’s production lines are interchangeable for manufacturing either cleanroom or healthcare gloves to suit the demand in each segment. Preference would be accorded to its high-value cleanroom gloves for its new production lines, which could help to boost profit margins. 
  • Otherwise, management expects to maintain its production volume mix between healthcare and cleanroom gloves at 80:20 following the capacity expansion.
  • Shipment volume growth for cleanroom gloves could be offset by the shrinking hard-disk drive (HDD) segment. In 2Q18, c.20% of cleanroom glove volume was attributed to the HDD segment, while the growing non-HDD segment (e.g. smartphone lenses, car sensors, batteries) accounted for the remaining 80%, as guided by management.

Laggard play compared to Malaysian-listed peers

Price catalysts to narrow valuation gap between RSTON and Malaysian-listed peers

  • Riverstone is currently trading at a 30% discount to Malaysian peers’ (ex-Hartalega) CY19F P/E average of 20.5x. implying that its current valuation of 14.3x FY19F P/E is undemanding. Riverstone appears to be a laggard behind its Malaysian peers in terms of forward P/E valuation, despite our expectation that its core EPS growth would pick up this year, with profit margins stabilising and capacity expansion.
  • The valuation gap between Riverstone and its Malaysian-listed peers has widened since 2017, which corresponds with the strong recovery in core EPS growth of the Malaysian glove makers. 
  • A potential key re-rating catalyst could come from accelerated demand growth for cleanroom gloves that could outstrip that of its healthcare gloves. This catalyst may drive stronger future EPS growth, in our view.

Colin TAN CGS-CIMB Research | https://research.itradecimb.com/ 2018-08-17
SGX Stock Analyst Report ADD Maintain ADD 1.30 Up 1.280