Riverstone (SGX:AP4) | A New Normal

Updated: Aug 11


Key Points

  • Riverstone reported stellar 1H21 results with revenue growing by 222.2% to MYR 2.0b and net profit swelling 656.8% to MYR 1.4b

  • Balance sheet remains robust with MYR 1.3b in net cash, representing 23% of market cap

  • ASP declines could be more gradual due to raw material price hikes and cleanroom segment strength

  • Volumes could be supported by strong cleanroom demand and expansion to other verticals

  • Wildcard scenario of aggressive breakthrough infections involving virus variants could be a boon to ASPs and volumes

  • Updated DCF-backed fair value of $2.01, representing potential upside of 58.8%

1H21 Results


Riverstone reported 1H21 results last night and we participated in their earnings call earlier today. Here are some highlights from their financial results:



Revenue rose to 3x y/y to MYR 2.0b, driven by continued demand from both the cleanroom segment (beneficiary of technology equipment manufacturing), as well as the healthcare segment (beneficiary of COVID-19 related PPE tailwinds).


Gross profit ballooned 7x to MYR 1.4b as a result of a favourable demand-supply dynamic, which placed upward pressure on ASPs. Resultantly, gross margin expanded by 37.5 ppts to 69.1%.


Operating expenses were largely kept in check, with S&D expenses increasing 67.2% to MYR 15.6m due to heightened sales efforts, while G&A expenses expanded by 96.8% to MYR 30.9m on higher performance incentives for staff. Accordingly, the group benefited from substantial operating leverage, with operating profit soaring by 675% to MYR 1.36b (67.3% operating margin).


Net profit skyrocketed ~6.6x to MYR 1.0b, in line with its boosted operating performance, resulting in operating cash flow also strengthening to 4x 1H21 levels to MYR 1.1b.


Balance sheet remains rock solid with MYR 1.3b in net cash, or ~23% of the current market cap.

Our Updated Riverstone Thesis


1. Market might be overly cautious of steep ASP declines


ASPs likely peaked in 2Q21, not 1Q21


Analyses of Riverstone's Q/Q numbers show that gross margins expanded despite a dip in revenues. This is indicative of rising blended ASPs and falling volumes in 2Q21, contrary to market concerns over ASPs peaking in 1Q21. We opine that healthcare ASPs remained elevated during 2Q21, but should start to drop in 3Q21 as distributors hold off new orders while depleting their current inventory.



Raw material price hikes could provide ASP floor


That being said, with key raw materials Acrylonitrile and Butadiene hovering at ~1.5-2x 2019 levels, we think that blended ASPs should not fall back to pre-COVID-19 ranges of ~US$25/carton for healthcare gloves and ~USD$60/carton for cleanroom gloves in the medium term. Riverstone typically employs a cost-plus pricing model for its gloves and we believe customers should be willing to accept higher ASPs in an inflationary environment for raw materials driven by higher oil prices.



Cleanroom strength should help smooth out ASP declines


We believe that Riverstone's strength in higher-end cleanroom gloves would partially cushion the impact of any dips in healthcare ASPs. Besides having higher ASPs and margins, cleanroom glove prices also tend to be less volatile as customers are typically locked into longer deals (ie. quarterly, semi-annual, annual) compared to monthly price revisions for healthcare gloves. We think this should slow down the rate of decline for blended ASPs and provide medium-term earnings visibility.


2. Long-term volume could be supported by capacity expansion and new customers


Near-term healthcare volumes will likely be negatively impacted


We believe 2H21 volumes will take a hit as healthcare glove distributors continue to deplete their high-cost inventory and hold off new orders in anticipation of further ASP declines. This is compounded by temporary capacity constraints face by the group as they dealt with a small-scale COVID-19 outbreak within their premises in June this year.


Cleanroom volumes likely to remain strong moving forward


Riverstone has been increasing its volume share of cleanroom gloves, with the potential to ramp up to 25% of total production from the current ~20%. This will be supported by the acquisition of a land bank in Jan 2021 which would help expand annual cleanroom glove capacity by 0.5b to 2.5b p.a.


Furthermore, cleanroom volume should be less affected by demand-supply dynamics in the healthcare markets. Therefore, we think that high demand for cleanroom gloves should continue to be sustained if the global technology manufacturing sector remains robust.


Moreover, Riverstone's dippling lines are interchangeable - Should management envisage a dip in healthcare volumes, the company could repurpose healthcare dipping lines to cleanroom gloves to manage its overall volumes and margins.


Riverstone well-poised to retain and acquire customers


We remain confident in Riverstone's capabilities to retain its customers, who stay loyal due to the group's ability to consistently adhere to high product quality and ESG standards. We are hearing that ESG is a growing priority in top-tier distributors' purchasing decisions. Therefore, should other glove OEM manufacturers face issues with ESG compliance, we believe Riverstone could be a strong alternative for distributors and end customers.


Furthermore, the group is already looking to expand into other verticals besides healthcare and cleanroom, with possible new business opportunities in untapped markets such as the food processing, pharmaceutical and surgical glove segments. We think that these new initiatives should contribute positively towards volume sustainability.


To support this growth, Riverstone is forging ahead with prudent expansion plans, with 1.5b annual glove capacity coming online for the next 2 years. We are comfortable with this expansion schedule as we believe it strikes a balance between volume growth and ASP compression arising from increasing supply.



3. Hedge against COVID-19 variant wildcard


We opine that Riverstone could be a beneficiary of any potential aggressive breakthrough infections, which might be driven by more infectious COVID-19 variants.


While global innoculation rates are increasing, we are still witnessing a huge spike in cases, mainly driven by infections in Asia.


(Source: AMRO Asia)


In other parts of the world, hospitalisation rates have also been rising in the US and the UK.



This situation was mostly perpetuated by the highly infectious Delta variant, which has led to fresh lockdowns in countries like China, The Philippines, Australia and Thailand. Meanwhile, recent reports have indicated that the Lambda variant of the virus could display resistance to current vaccines.


While the global healthcare situation remains volatile, we believe that the discovery of more variants of concern could keep public healthcare measures elevated in the medium term. This would would bode well for PPE demand as healthcare institutions continue to replenish their stockpiles. Aggressive breakthrough infections could also increase the urgency of procuring PPE.


Valuation


We updated our DCF model, which Snowball Community members can [download here] to reflect our thesis. We obtained a fair value estimate of $2.01, representing potential upside of 58.8% from the last close of $1.27.


Key Assumptions

  • Healthcare ASPs hit US$75/carton in 2021 before tapering to US$45/carton in the next 2 years

  • Cleanroom ASPs hit US$130/carton in 2021 before tapering to US$110/carton in the next 2 years

  • Utilisation rate at 80%

  • Cleanroom volume share at 22% until 2023

  • WACC ~10%, 8.0x EV/EBITDA exit multiple


Catalysts


1. Bumper FY21 dividend


We note that 1H21 EPS of 70.22 sen has already surpassed FY20's EPS of 43.7 sen. Assuming Riverstone maintains its FY20 payout ratio of 50.4%, we can possibly expect a significantly higher FY21 dividend. Below is a sensitivity table laying out how FY21 yields could look like depending on various EPS and payout ratio assumptions, based on the last close of $1.27 (inclusive of 10 sen interim dividend declared in 1H21).



Riverstone had previously guided for capex to remain at ~MYR100m over the next few years. If this guidance holds true, Riverstone should have a significant excess cash on its balance sheet, backed by its sizeable net cash pile of MYR1.3b coupled with its strong OCF generating ability. This should provide management with the flexibility to fund a large dividend payout should they wish to do so.


2. Surge in COVID-19 cases driving increased urgency to procure PPE


A surge in COVID-19 cases globally could prompt healthcare institutions to increase their PPE stockpile, further accentuating the glove shortage. This should bode well for healthcare ASPs and volumes, which could drive operating leverage and disproportionate earnings growth.


Risks


Key risks include the global pandemic abating, which would hamper demand for healthcare gloves, as well as localised outbreaks in Riverstone's premises or MCO restrictions in its operating states which would reduce capacity.


Conclusion


We had previously sold out of Riverstone as its share price gained strength last year during the surge of global COVID-19 cases. However, the stock re-entered our radars when it got sold down fiercely together with other regional glove manufacturers. We personally believe that Riverstone's fundamentals remain attractive, and our downside risk arising from thesis drift could be cushioned by a potentially sizeable dividend payout. Therefore, we view Riverstone as an interesting call option on the wildcard scenario of aggressive breakthrough infections globally involving virus variants.


Thanks for reading,

Bryan and Jin Koi


Disclaimer: The Snowball Model Portfolio is long Riverstone at an average price of $1.24. This article is not an investment (buy/hold/sell or otherwise) recommendation, this is only for educational and discussion purposes. This article is not tailored to the specific circumstances of any reader. I/we/The Snowball do/does not purport to be in the business of providing financial advice and the contents of the article should not be regarded as such.


Cover photo source: Samsul Said/Bloomberg


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