Where to Next for This Growth Story?

Riverstone Holdings Limited (SGX:AP4) has been an outperformer over the last five years. The share price has recorded returns of about 103% from 1 Jan 2009 to the closing price on 8 October 2014. By comparison, the capital gain returns of the SPDR STI ETF (SGX:ES3), a proxy for the Straits Times Index (SGX:^STI), was 74% for the same duration. Over the past five financial years, the glove maker paid out a total of about RM$0.299 Malaysian sen per share in dividends.

While the returns from Riverstone has been stretching in the right direction — as Foolish investors, we should look behind the curtains to understand what the business drivers are for this move in the share price.

A Closer Look

Riverstone engages in high tech cleanroom gloves, and premium healthcare gloves. For the financial year ended 2013 (the calendar year lines up with the financial year), 90% of its products were nitrile gloves supporting both industries. The cleanroom glove are used at leading manufacturers of the electronics and hard-disk industry, while the healthcare gloves are used at hospitals and medical facilities. According to estimates from Maybank, cleanroom gloves made up 63% of its revenue for the financial year ended 2013.

The glove maker has five manufacturing locations with three plants in Malaysia, one plant in Thailand, and one plant in China.

riverstone graph 1

Source: Company Earnings Report; Geographical location of customer; Rest of the World includes European Customers

Riverstone does not breakdown the development of the cleanroom and healthcare gloves, but it does breakdown where it derives its revenue from. At the end of 2013, 35% of its sales came from Europe (shown here as Rest of the World), and 30.3% came from South East Asia. In the past five plus years, a large majority of the growth came from customers located in Europe.

We would ideally like to see the revenue dollars drip down to the bottom line. There is no geographical segment (by customer location) profits shared by its report, so we can look at the companies operating cash-flow, and capital expenses instead.

riverstone graph 2

Source: Company Earnings Report

The company has generated positive free cash flow (operating cash flow minus capital expenses) in the past five financial years. This is a healthy sign, given the need to continue to invest in capacity expansion for the manufacturing of its gloves.

Finally, Foolish investors would look for the accumulated profits have to end up on the balance sheet in the end. To do this, we look at development of its cash and borrowings.

riverstone graph 3

Source: Company Earnings Report

Again, Riverstone has a healthy balance sheet with negligible borrowings over the past five financial years. It should be noted that RM $10.6 million worth of warrants were converted to ordinary shares in 2012. For 2013, RM$32.5 million worth of warrants were converted to ordinary shares.

A quick look ahead

At the end of 2013, Riverstone had manufacturing capacity of 3.1 billion gloves, of which 40% were for the cleanroom industry, and 60% was for the healthcare industry. This was a sizable increase from its capacity of 2.5 billion at the end of 2011. The company purchased 30 hectares of land next to its Taiping plant where it plans to expand its capacity in five different phases. Each phase would add 1 billion additional capacity in gloves. From its recent second quarter report, the company shared that it expects the first phase to be operational by the end of 2014, and have at least 25% annual growth in volume.

It is also useful to understand Riverstone’s move into the more competitive healthcare glove market. In a speech given by Chief Executive Office (CEO) Wong Teek Son on 28 September 2013, he said that Riverstone started producing healthcare gloves in 2009. Although the industry came with lower margins, it also came with higher volumes and was more resilient to economic changes. The motivating factor for its move into the healthcare glove market was because Riverstone experienced significant drops in the demand for cleanroom gloves in 2008. This is one of the risks to take note.

Foolish Take away

As lifelong students of Foolish long term investing, it pays to look under the hood to understand whether a rise in the company’s share price is supported by the quality of growth that we are looking for.

Riverstone is focusing on lower volume, niche areas where it has less competition. It is also growing its capacity in stages, which might represent a more prudent approach to growing its business. Profit margins may decline slightly in the short term as the glove maker ramps up its utilization of its new plants. It is for the Foolish investor to decide on the risk profile of the company, and what size of portfolio allocation which might makes sense.

As of the closing price on 8 October 2014 $0.975, Riverstone traded at a price-to-earnings ratio of about 14 and has a dividend yield of around 2.7%.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.