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  • Kenny Chia

Riverstone Holdings | Revisited

Updated: Jun 14

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Key Points

  • Recent developments of the COVID-19 pandemic has strengthened the bull case for glove manufacturers and Riverstone in particular.


  • Glove makers are beneficiaries of the collapse in crude oil prices where more than half of operating costs are positively correlated with crude oil prices.


  • Riverstone's share price still remains below its 2015 all-time high of S$1.30 while major peers have already broken all-time highs.


  • Clear expansion plans till FY2022 with projected capacity growth of 47%-67% expected to be fully funded by operating cash flows.


  • Executive Chairman and CEO Wong Teek Son has been aggressively buying shares in the open market.


  • Revise target price of Riverstone upwards from S$1.50 to S$1.72. This implies a forward P/E and EV/EBITDA of 25x and 15.5x respectively. Peer averages currently stand at 34.5x and 21.7x respectively.

This post is meant to provide an update on my investment thesis for Riverstone Holdings since the Arohi Asset Management Stock Challenge on 7th February 2020. You can find the slide deck of the initial thesis [here]. The narrative has since changed dramatically and I am more bullish on the company than I was a few months ago.


To recap, Riverstone manufacturers and distributes cleanroom and healthcare gloves. 95% of Riverstone's revenue is derived from the sale of nitrile gloves. 85% of the sales volume comes from healthcare gloves while the remainder of the sales volume comes from cleanroom gloves. In terms of region, Riverstone derives the bulk of its revenue from Europe, Southeast Asia, and the USA.


Riverstone is a founder-led company with its founder, Executive Chairman, and CEO Wong Teek Son holding a 51% stake in the company. Co-Founder, Executive Director, and COO Lee Wai Keong holds an 11% stake while Executive Director and Group Business Development Manager Wong Teck Choon (Wong Teek Son's brother) owns a 3% stake. In aggregate, the key management owns a 65% stake in the company.

In a recent interview with the Business Times, Riverstone's founder shared some valuable insights as to how the business is performing amidst the pandemic. From a revenue standpoint, we can see that Riverstone has benefitted from higher ASPs as well as higher sale volumes for its healthcare gloves.


From an operating cost standpoint, we need to dig deeper into the operating cost breakdown of a typical nitrile glove manufacturer. Since Riverstone does not disclose such a breakdown, I will be using Top Glove's nitrile glove operating cost breakdown as shown below as a proxy.

As shown above, the raw materials for nitrile gloves, butadiene and acrylonitrile, has declined considerably since the second half of 2019. Since these raw materials account for a significant portion (~46%) of operating costs, Riverstone is expected to reap significant cost-savings. The decline in crude oil prices is also expected to reduce fuel costs for Riverstone.


From an FX standpoint, the recent weakening of the MYR against the USD bodes well for Riverstone given that the bulk of its revenue is in USD while its costs are in MYR. As shown its the notes to the financial statements in the annual report, a 1% strengthening of the USD/RM increases Riverstone's net profit before tax by RM1.28m. Should the USD/RM pair hold at these levels or even strengthen, Riverstone will reap FX gains.


Hence, we can see that recent developments provide numerous tailwinds for Riverstone. ASPs and sales volumes have increased, unit operating costs are expected to decrease, and currency movements have been in favour of Riverstone.


Riverstone released its annual report 2019 about 2 weeks ago, I have written the key points above. It is noteworthy that during this pandemic, while most companies are downsizing and cutting costs, Riverstone has officially announced a new three-year expansion plan from now till FY2022, which will be fully-funded by its operating cash flows. The company will expand capacity by up to 67% over the next 3 years. Riverstone had already been preparing for this expansion pre-COVID-19 due to increasing demand for nitrile gloves globally. The company has already bought the raw land necessary for its production lines in 2018 and 2019. The emergence of COVID-19 has simply accelerated the industry's growth.


One of the processes of nitrile glove manufacturing is the stripping of the gloves from the moulds and packing them into the packaging. This step is extremely labour intensive and thus forms a large portion of operating costs (~10%). Given Riverstone's automation initiatives, we should be able to see some additional margin expansion from the productivity gains.

I have been following Riverstone since early 2014 (vested till late 2015 and again in Feb 2020) and have never seen the founder, Wong Teek Son, buy shares in the open market until recently during the irrational sell down of Riverstone where Malaysia announced that it would be under lockdown and global markets were falling sharply.


He began buying shares aggressively in the open market since 19 Mar 2020. Thus far, he has spent a total of S$2m buying 2.18m shares at an average price of S$0.91. The highest price he paid during this period was on 17 Apr 2020, at an average price of S$1.19. Based on the FY2019 remuneration band, the founder essentially spent more than 4 years of his salary in increasing his stake in Riverstone over the past month. It is one thing to use the company's cash to conduct share buybacks and another where key management is using his own cash to increase his personal stake in the business. It is probably safe to say that Wong Teek Son sees substantial upside (i.e.>50%) over the long term to justify his recent purchases.


As shown in the chart below, Riverstone is still under its 2015 all-time high. Glove makers as a group reached all-time highs during that period due to the significant depreciation of the MYR relative to the USD as well as the fall in crude oil prices.


Given the current environment, glove makers are well-positioned to benefit from higher ASPs and lower costs. With the exception of Riverstone, all major glove players have exceeded their 2015 levels and are currently at all-time highs.


As shown above, valuation multiples (forward P/E and forward EV/EBITDA) for Riverstone are the lowest relative to peers. This could be due to the fact that Riverstone is listed on the SGX while the peers are listed on the Bursa. Riverstone is also the smallest in terms of market capitalization relative to the peers so there could be some small-cap discount being applied to it. In terms of profitability and balance sheet strength, however, Riverstone stands out with its above-average margins and net cash position. Hence, Riverstone has a wide room for multiple expansion and is bound to break above its 2015 all-time high share price of S$1.30 eventually.

Based on our financial model, which you can [download here], we derived a target price of S$1.72 for Riverstone. This represents an upside of 44.3% from the last closing price of S$1.19. We will adjust the model accordingly as the ongoing narrative develops.


Our key assumptions are as follows:

  1. WACC of 8% - We adjusted WACC upwards by 1.3% to be more conservative

  2. Utilization Rate of 90% - We adjusted utilization rate to historical average to be more conservative despite reports that utilization rates are now above 90%

  3. No change in overall ASPs in both healthcare and cleanroom gloves - while ASPs for healthcare gloves are reported to have increased, we are less optimistic on the cyclical cleanroom gloves

  4. Stable gross and operating margins - we did not factor margin expansion in the model to be conservative in case of unforeseen revenue and cost pressures

  5. EV/EBITDA multiple expansion from the present 12.5x to 15x by FY2022 - driven by accelerated earnings growth and flight to defensive plays

  6. Additional 1.4 bn capacity added each year - as stated in the FY2019 annual report


Any negative violation of the above assumptions would affect the target price to the downside.

Conclusion

I began accumulating shares of Riverstone since Feb 2020 and it now forms one of my core long-term equity holdings. Riverstone has emerged as a beneficiary of this pandemic as well as the collapse in crude oil prices. Notwithstanding the global healthcare glove industry growth rate of 8-10% pre-COVID-19, consumption of healthcare gloves will remain at elevated levels while this pandemic lasts. I do not know when this pandemic would end but I am fairly confident that, in a few years from now, Riverstone's intrinsic value will be at much higher levels than where the share price is right now. I'm betting on it.


Thanks for reading,

Kenny


Disclaimer: I am long Riverstone Holdings at an average price of S$1.05. This is not a buy recommendation, this is only for educational and discussion purposes.


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