@ Riverstone's glove manufacturing plant in Taiping, Malaysia, which opened in 2H2014.
NextInsight file photo.
Excerpts from analysts' report
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WHAT’S NEW
A mid-cap gem. We spoke to the management of Riverstone Holdings (Riverstone) for an operational and execution update. This note highlights the key takeaways and key investment highlights.
Background on Riverstone. Riverstone specialises in the production of nitrile gloves. It is the leading global supplier of high-tech cleanroom gloves with an estimated 60% share in the hard disk drive (HDD) market. It also manufactures premium customised healthcare gloves. Additionally, the group produces other cleanroom consumables such as finger cots, packaging materials and face masks. Currently, Riverstone operates six manufacturing facilities in Malaysia (four), Thailand (one) and China (one), with an expected combined annual production capacity of 5.2b gloves by 2015.
STOCK IMPACT
Global leader in the high barrier-to-entry, premium-priced cleanroom segment. Cleanroom gloves are made for special industrial applications conducted in a critical environment. It mainly serves the high-tech electronics manufacturing sector. Due to the advanced technical capabilities involved, cleanroom gloves typically command ASPs that are 2.5-3x higher than healthcare gloves. Barriers to entry are very high due to the highly specialised nature of manufacturing cleanroom gloves. Riverstone’s long-standing bluechip customers include Western Digital, Seagate and Hitachi, some of whom source their needs solely from the group.
Capable of sustaining healthy margins. We are confident about the group’s ability to defend its gross margins, especially within the cleanroom segment. Riverstone’s firstmover advantage and its understanding of the cleanroom glove market differentiate the group from competitors. In addition, smaller glove makers would likely face difficulties in producing the relatively more complex cleanroom gloves, which would require large investments dedicated to R&D. The group is expected to maintain its cleanroom glove gross margins at 32-36% and healthcare glove margins at 15-20% in 2015.
Expansion plans are on track. Development of phase 2 is underway with completion targeted for 3Q15 as Riverstone plans to add 1b pieces in capacity every year and expand total capacity to 8.2b pieces by 2018. The product mix of 70% healthcare gloves and 30% cleanroom gloves is likely to remain unchanged. We think that the risk of overcapacity is low as the group is expanding prudently, and new orders and uptake from existing customers are strong. The development of phase 2 consists of six lines (four double production lines and two single production lines), of which three lines have been taken up by existing customers. We expect an average utilisation rate of 90% post the phase 2 expansion.
Beneficiary of a stronger US dollar and higher tax incentives. Malaysian glove makers are likely to benefit from a rising US dollar as most of their sales are in US dollars. For every 1% strengthening of the US dollar, we expect Riverstone to benefit by RM0.7m in profit before tax. The US dollar has strengthened 7.1% against the ringgit over the last six months. In addition, Riverstone benefitted from about RM10m in tax incentives in 2014 and we expect the group to continue enjoying an additional RM7.5m in tax incentives in 2015. These tax incentives are due to rebates from the Malaysian government for Riverstone’s investments in additional production capacity. Debt-free and cash-generative. With RM40m in cash, RM26.2m in operating cash flow and being debt-free as at 1Q15, the group is in a good position to maintain their target of 45% in dividend payout ratio. We expect the group to remain free cash flow positive.
EARNINGS REVISION/RISK
Raise 2015 and 2016 net profit estimates by 4.0% and 5.0% respectively on the back of higher utilisation rates assumptions as Riverstone ramps up.
We project a 3-year net profit CAGR of 18.8% in 2014-17 on the back of: a) strong take-up of its cleanroom gloves in the tablet and mobile segment, b) resilient demand from the healthcare sector, and c) production capacity expansion. In addition, while the healthcare glove industry remains competitive, low raw material prices will protect margins. We see room for further upside from better-than-expected ASPs, margins and utilisation.
VALUATION/RECOMMENDATION
Undervalued glove maker, BUY with target price of S$1.59 (up from S$1.51), pegged at the sector’s historical mean PE of 14.2x applied to our 2016F EPS of 11.2 S cents. Given the higher ROE and yield, Riverstone is trading attractively at 2015F and 2016F PE of 15.9x and 12.8x, vs peers’ average of 17.9x and 15.9x respectively.
KEY RISKS
Margin compression from higher raw material prices and production costs.
Foreign exchange risk.
Oversupply of healthcare gloves and intense competition.
Cyclical risk from high exposure to the electronics industry.
Counterparty risk
