Riverstone – A potential technology play?

Dear Readers,

Below is my writeup on Riverstone. I am not able to attach some of the figures on my blog. Readers who are interested can drop me an email at crclk@yahoo.com.sg


Riverstone – A potential technology play?

Of late, technology plays have been in play, especially in the first two months of this year. Hard disk drive (“HDD”) manufacturers such as Seagate and Western Digital have spotted impressive year to date returns of 80% and 34% respectively. This optimism has also filtered to our Singapore listed HDD component manufacturers such as Armstrong and Broadway which have jumped 33% and 52% respectively year to date. In addition, most market watchers are expecting HDD players to rebound after the Thai flood. Coupled with the positive industry momentum, there seems to be a wave of takeovers on the technology sector such as Meiban and Adampak. A proxy that comes to my mind is Riverstone who counts the major HDD players such as Seagate, Hitachi, Western Digital, Toshiba and Samsung etc and semiconductor companies such as Infineon and Texas Instruments etc as its key customers.
Although Riverstone has significantly increased its annual production capacity from 720m gloves in 2006 to 2,500 in 2011, it managed to generate positive free cash flow and gives dividends every year since 2006. In fact, it is net cash since 2006. As it seems to be a conservative, yet well run company, I have arranged an exclusive meeting with Riverstone’s key management, namely Mr Wong Teek Son, Executive Chairman and Chief Executive Officer and Mr Lim Sing Poew, Chief Financial Officer (collectively “management”) for a discussion of their company business and prospects.
Readers who are not familiar with Riverstone can refer to Annex A & B for more information.
Key takeaways from management meeting
Worst is likely over for HDD industry
HDD industry went into a tailspin after the worst flood hit Thailand, the world’s largest manufacturing hub for HDDs in more than half a century. As the floods subside and rebuilding commences, demand is likely to pick up especially when there was a shortage of HDD in 4Q. Management echoed this view and postulated that demand is likely to resume in second half as the industry continues to face some supply constraints in the first half of 2012.
Diversification to healthcare gloves bears fruit
Notwithstanding the flood in Thailand, Riverstone’s 4QFY11 revenue rose 20% from MYR60m in FY10 to MYR72m in FY11. This was mainly attributable to higher sales for healthcare gloves which offset the lower sales in cleanroom gloves. This was a sound testament to management’s prescient move into the healthcare industry since 2009.
Besides the timely move into healthcare industry, their rapid expansion in the healthcare industry is noteworthy. They started with zero pieces of healthcare gloves in 1QFY09 and this surged to 900m pieces in FY11 (see Table 1). Management shared with me that this rapid expansion was the result of a continuous focus in quality and research and development (“R&D”) efforts. They have a strong team of 20 chemists to engage in R&D work which provides highly customized solutions to their customers. Management also emphasized that the size of the healthcare industry is significant at around 150-200b pieces of gloves per year and growth is likely to rise approximately 10% per annum.
Table 1: Number of gloves sold in cleanroom vs healthcare
Vol sold (m pieces)
2010
2011
Cleanroom gloves
800
750
Healthcare gloves
300
900
Total
1,100
1,650

Source: Company and Ernest’s compilations
Capacity to increase to 2.8b pieces this year
With reference to Figure 1, Riverstone is adding three dipping lines at their Malaysia plants to raise their annual production capacity to 2.8b pieces of gloves in 2012. Furthermore, they are refurbishing their old lines to increase their capacity per line.
Figure 1: No of gloves at the end of each year
Source: Company
Investment merits
Management also shared with me the investment merits of their company. Firstly, notwithstanding the vagaries of their business cycles, management pointed to their consistent track record of paying dividends since 2006. (See Figure 2). At the current price of $0.440, FY11 dividend yield is around 5.5%.
Figure 2: Dividends per share since 2006
Source: Company
Secondly, management added that 2012 would benefit from a full year impact of the expansion in capacity in 2011; average production capacity in 2011 was 2.0b pieces of gloves per annum compared to that of 2.5b at 2011 year end.
Thirdly, management is cognizant that they are small relative to their peers. However, management believes that being a small player has its benefits. They can service some customers with their customized solutions which Top Gloves may not find it worthwhile to. Furthermore, Riverstone, with its smaller base, is likely to grow faster than its peers.


Investment risks
Management is candid about the challenges which they face in their business. Firstly, the volatile swings in the USD currency against MYR (see Figure 3) have an adverse impact to the company. This is because about 60-70% of Riverstone’s sales are denominated in USD but only 40-55% of their expenses are denominated in USD, thus the net portion is exposed to the fluctuations in USD/MYR. Although management hedges the remaining exposure to a certain extent, the fluctuating USD does accentuate some challenges.
Figure 3: USD against MYR 1 year chart
Source: Yahoo Finance
Secondly, according to The Malaysian Insider, Malaysia is seeking to announce a minimum wage policy by the end of the month, probably in the region of MYR800 & MYR900 for Peninsular and East Malaysia respectively. Labour costs in China are rising too. To mitigate such labour cost pressures, Riverstone is embarking on more automation and streamline their manufacturing processes. 
Thirdly, according to CIMB Research, fuel costs are on the rise as the previous gas subsidies amounting to a staggering MYR23b in 2011 are unlikely to be sustainable. To control costs, Riverstone has already commissioned a new biomass water tube boiler each at Taiping and Bukit Beruntung in 2011 and is seeking to achieve a balanced usage of biomass and gas.
Another noteworthy point is that Riverstone has about 48.97m warrants outstanding which can be converted to an equivalent number of Riverstone common shares at the exercise price of S$0.31 each. The warrants expire on 4 Aug 2013. As the warrants are in the money, it is likely that they may be exercised and there would be share dilution. However, these additional funds may prove useful to the management for expansion or other purposes and may enhance shareholder value over the long term.
Valuations discount vs peers; higher estimated dividend yield
With reference to Table 2 below, Riverstone seems to be trading at a slight discount relative to the FY12F industry average PE of 11.3x. It also has a higher estimated dividend yield of around 5.2% as compared to 3.4% for their peers. It will be interesting to see how they fare in the next few quarterly results.
Table 2: Comparison of Riverstone vis-à-vis its peers
Short Name
Cur
Last Px
Analyst TP
Change in TP
1 Yr high
1 Yr low
Adj Mkt Cap (S$m)
FY11 PE
FY12F PE
ROE (%)
Fwd Div Yield (%)
Riverstone Hldgs
SGD
0.44
0.57
29.5
0.47
0.33
141.9
8.9
9.6
18.2
5.2
Adventa Bhd
MYR
1.47
1.73
17.9
2.30
1.43
91.4
78.6
11.1
1.9
5.1
Hartalega Hldgs
MYR
7.85
8.16
3.9
8.54
5.00
1,166.7
14.0
13.9
44.9
3.5
Kossan Rubber In
MYR
3.21
3.88
20.8
3.67
2.48
417.5
11.2
9.0
19.4
2.8
Latexx Partners
MYR
1.45
1.74
20.0
2.74
1.17
131.4
7.3
6.0
17.5
3.3
Supermax Corp
MYR
1.90
2.10
10.5
2.38
1.13
525.7
12.2
9.6
14.5
2.8
Top Glove Corp B
MYR
4.65
4.88
5.0
5.88
3.85
1,170.2
21.1
18.0
10.2
2.8
Average ex Riverstone
24.1
11.3
18.1
3.4

Source: Bloomberg (26 Apr 12)


Annex A – Description of Riverstone

Source: Bloomberg (20 Apr 12)
Annex B – Analysts’ target prices

Source: Bloomberg (20 Apr 12)


Disclaimer
The information contained herein is the writer’s personal opinion and is provided to you for information only and is not intended to or nor will it create/induce the creation of any binding legal relations. The information or opinions provided herein do not constitute an investment advice, an offer or solicitation to subscribe for, purchase or sell the investment product(s) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of this information. Investments are subject to investment risks including possible loss of the principal amount invested. The value of the product and the income from them may fall as well as rise. You may wish to seek advice from an independent financial adviser before making a commitment to purchase or invest in the investment product(s) mentioned herein. In the event that you choose not to do so, you should consider whether the investment product(s) mentioned herein are suitable for you. The writer will not, in any event, be liable to you for any direct/indirect or any other damages of any kind arising from or in connection with your reliance on any information in and/or materials appended herein. The information and/or materials are provided “as is” without warranty of any kind, either express or implied. In particular, no warranty regarding accuracy or fitness for a purpose is given in connection with such information and materials.

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