Riverstone Holdings - DBS Research 2019-08-13: Improving Margins And Valuations

RIVERSTONE HOLDINGS LIMITED (SGX:AP4) | SGinvestors.io RIVERSTONE HOLDINGS LIMITED (SGX:AP4)

Riverstone Holdings - Improving Margins And Valuations

  • Upgrade to BUY on improving product mix, stabilising raw material prices and attractive valuations.
  • Raised earnings estimates by 7% for FY19F and FY20F; Target Price increased to S$1.16.
  • Beneficiary of a strengthening USD vs MYR.
  • 2Q19 met estimates; steady improvement in GP margin.


Upgrade to BUY on improving product mix, stabilising raw material prices and attractive valuations.

  • We upgrade RIVERSTONE HOLDINGS LIMITED (SGX:AP4) to BUY on increasing demand for its high-margin cleanroom (CR) gloves, which account for 70% to 80% of the group’s earnings. Butadiene prices, the key raw material for nitrile glove, are stabilising after a steep decline in 2H 2018, which is the most ideal environment for Riverstone.
  • At current price-to-earnings (PE) of 14.8x and 13.6x on FY19F and FY20F earnings respectively, Riverstone is trading at its historical low forward PE, which is about -2SD (standard deviation).
  • Compared to its peers, it is trading at about 30% discount. This is unjustifiable, in our view, given the expected shift towards higher-margin CR and a stabilising raw material environment. Riverstone is also a beneficiary of the strengthening US Dollar (USD) vs Malaysian Ringgit (MYR).
  • We see value in Riverstone’s hard-to-replicate cleanroom business that sets it apart from its competitors. Glove makers are generally regarded as defensive and relatively more stable given their resilient demand.


Where we differ:

  • We are optimistic that Riverstone can continue to shift its production towards the higher margin CR gloves.


Potential Catalysts:

  • Further capacity expansion, sustained increase in CR glove mix (and thus margins) and inorganic growth are potential catalysts.


WHAT’S NEW



Cleanroom gloves to drive future growth


Increasing demand for high-margin cleanroom gloves

  • Cleanroom (CR) gloves account for about 15% of Riverstone’s total units produced, with healthcare (HC) gloves forming the bulk of the balance 85%. Given the higher average selling price (ASP) for CR, the revenue split for CR / HC is 53% / 47%. CR commands a much higher margin given its stringent qualifying requirements. CR accounted for 75% Riverstone’s earnings in the last quarter (vs 25% by HC).
  • Since June 2019, Riverstone has seen a pick-up in CR demand. This trend is expected to continue in 2H19. Demand for CR has grown by about 15% to 20% compared to last year, from countries including Japan, Philippines and Vietnam.

Raw material prices stabilising

  • Butadiene prices are stabilising, which is the most ideal environment for Riverstone. Butadiene prices have been fluctuating within a narrower band of between US$900/metric tonne to US$1200/metric tonne YTD, since prices plunged 40% in 2H18 mainly due to the US-China trade tensions. High raw material prices affect ASP, especially for the HC glove segment as most of the cost savings are passed on to customers.
  • On the inventory front, lower raw material prices would allow the group to lock in more inventory at a lower cost, though there would still be a one-to two-month lag before the old stock is cleared. A more stable butadiene price is the most ideal environment for the group, allowing a more manageable inventory environment.

Trading at historical low PE and at steep discount to peers

  • At current PE of 14.8x and 13.6x on FY19F and FY20F earnings respectively, Riverstone is trading at its historical low forward PE, which is at about -2SD. Compared to its peers, it is trading at about 30% discount. This is unjustifiable, given the expected shift towards higher-margin CR and a stabilising raw material environment.


Forex Exposure


Beneficiary of a strengthening USD

  • The bulk of Riverstone’s sales are denominated in USD while costs are mainly in MYR. A strengthening USD/MYR is beneficial to the group, though the impact is not fully reflected in the earnings. Foreign exchange (forex) movements are partially captured in the pricing formula during regular (monthly/quarterly) price negotiations with customers. There would usually be a one-month lag before the impact can be felt.
  • The USD has strengthened against the MYR from about 4.11 in mid-July 2019 to about 4.18 currently. DBS Group Research expects the USD to further strengthen against the MYR to 4.25 in 3Q19 and ease gradually to 4.23 in 4Q19 and 4.15 in 4Q20.


Competitive Landscape


Demand and supply dynamics

  • Malaysian Rubber Glove Manufacturers Association (MARGMA) expects an annual demand growth of about 12% to 300bn gloves in 2019. We project a ramp-up in Riverstone’s glove production at a 17.5% compound annual growth rate (CAGR) in FY17-19F. Other key players including Top Glove, Hartalega and Kossan Rubber are also expected to increase capacity by about 10% p.a.
  • We believe Riverstone should emerge as a stronger player, especially with the shift in demand to nitrile gloves from latex gloves due to the rising awareness about latex allergies. Nitrile gloves are also more puncture resistant, provide stronger protection and offers greater chemical resistance than regular latex gloves. Nitrile gloves have lower resistance to friction, making them easier to wear and discard.
  • Riverstone could be a beneficiary of the long-run substitution from rubber gloves and PVC gloves (especially in the cleanroom segment) to nitrile gloves as the company is principally engaged in the production of the latter.

Diversified customer base

  • Glove makers are generally regarded as defensive and relatively more stable given their resilient demand and cost pass-through
  • mechanism, especially for healthcare gloves. A diversified global customer base also reduces their exposure to a single geographical region. About 30% of healthcare glove customers are from Europe, US (30%) and Asia (40%).
  • Cleanroom glove customers are mainly from the Asia Pacific region, especially the electronics and telecommunication sectors.

Competition from new players

  • In Malaysia alone, there are about 40 glove manufacturers. Coupled with new players from other regions including China, competition is keen in this space. Chinese players are also more competitive in terms of pricing but Malaysia has an advantage over China in terms of climate.
  • Our channel check indicates that some demand has shifted back to Malaysia in recent months as raw material prices stabilised.
  • Expansion plans on track, demand strong. Riverstone will add an additional capacity of up to 1.4 billion pieces of gloves by the end of 2019 / 1Q2020 with Phase 6 of its expansion plan.
  • This will bring the group’s total annual production capacity up to 10.4 billion pieces of gloves. Utilisation rate remains high at > 90%, despite the capacity expansion.
  • Despite rising competition, demand for the group’s products remains robust. Riverstone has secured more orders from existing and new customers, including glove distributors switching to Riverstone due to its improving product range.


New products and improving efficiency

  • Riverstone has a few new products in the pipeline, including one that expects to meet double glove requirements in some sectors like healthcare. Different materials and processes are needed for the two gloves to be worn together. The group’s research and development (R&D) team are developing new products to venture into new product segments, diversify its business and improve profit margins.
  • With a competitive landscape, Riverstone will continue to adopt automation within its operations to raise productivity and ensure earnings resiliency.


2Q19 Results Review


2Q19 results in line.

  • Riverstone’s revenue was up 11.9% y-o-y to RM239.7m, driven by an uptick in demand for both its premium cleanroom and specialty healthcare gloves. However, net earnings eased 3% y-o-y to RM32.5m on the back of lower ASP and higher costs.
  • Overall, 2Q19 revenue and net earnings accounted for 24% and 25% of our forecasts, within our expectations.
  • An interim dividend per share (DPS) of 1.55sen was declared.

Steady improvement in GP margin.

  • Though on a y-o-y basis the group’s gross profit margin contracted 2.4 percentage points to 20.1%, it improved compared to the previous two quarters. The lower margins (y-o-y) were due to lower ASP for healthcare gloves and changes in product mix. Apart from intensifying competition, the ASP of gloves was revised downward due to macroeconomic variables such as lower raw material prices as the group adopts a cost-plus pricing model.
  • On a q-o-q basis, GP margin has improved steadily since 4Q18, expanding 0.5 percentage points to 19.4% in 1Q18 and 0.7 percentage points to 20.1% in 2Q19.

Strong balance sheet.

  • Riverstone’s core business continued to generate strong positive operating cash flows of RM22.3m in 2Q19, bolstering its balance sheet strength to a net cash position of RM76.4m.


Raised earnings estimates by 7% for FY19F and FY20F; Target Price increased to S$1.16.

  • We have raised our earnings forecast up by 7% on higher gross profit margin assumption of 20% (vs 19% previously) for both FY19F and FY20F.
  • Upgrade to BUY with a higher Target Price of S$1.16 (prev S$1.03) still based on 20% discount to peers (17.4x) and rolling over to FY20F earnings.





Lee Keng LING DBS Group Research | https://www.dbsvickers.com/ 2019-08-13
SGX Stock Analyst Report BUY UPGRADE HOLD 1.16 UP 1.030



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