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Investors Take Note: 2 Similar Companies Can Face Very Different Risks

In Singapore’s stock market, it’s not uncommon to find many different companies with outwardly similar-looking businesses.

A nice example would be the pair of UG Healthcare Corporation Ltd (SGX: 41A) and Riverstone Holdings Limited (SGX: AP4) – both companies are natural rubber and nitrile (a form of man-made rubber) glove manufacturers based in Malaysia.

But, it’s important for investors to note that just because they have outward similarities does not mean that they face the same type of business-risks.

Earlier in the month, I wrote about the risk of UG Healthcare facing a possible slowdown in future production because its inventory growth in recent years has far exceeded that of its revenue growth.

To recap, investor and author Thornton O’Glove warned in his book Quality of Earnings that investors ought to be wary if a company’s inventory starts spiking at a much faster pace than revenue. He wrote that “excesses of inventory, time and time again, is a good indicator of future slowdown in production.”

I had produced the following chart in my earlier article about UG Healthcare, showing the divergent growth-paths that the firm’s revenue and inventory had been on for the financial years ended 30 June 2013 and 30 June 2014 (FY2013 and FY2014, respectively).

UG Healthcare inventory and revenue growth

Source: UG Healthcare IPO prospectus

As you can see in the next chart below, Riverstone’s inventory and revenue picture looks decidedly different. Whereas UG Healthcare saw its inventory balloon by 33.9% in FY2014 while its revenue grew by only 4.2%, Riverstone’s top-line and inventory had increased at year-on-year rates of 10.3% and 18.4%, respectively, for the 12 months ended 30 September 2014.

Put another way, Riverstone’s inventory and revenue have been growing at rates which are far less divergent when compared to that of UG Healthcare’s.

Riverstone inventory and revenue growth rate

Source: S&P Capital IQ

This shows that the risk profiles for the two companies can be very different. And in fact, a closer examination of their businesses would also reveal the same picture.

For instance, analysts have estimated that approximately two-thirds of Riverstone’s revenue come from gloves manufactured for use in cleanrooms (in other words, for use by electronics manufacturers); in contrast, UG Healthcare’s gloves are used predominantly in the healthcare industry. In addition, close to 90% of Riverstone’s revenue is derived from nitrile gloves whereas UG Healthcare’s nitrile-based glove products make up only slightly more than one-third of its overall sales currently.

A Fool’s take

UG Healthcare and Riverstone might look similar on the surface, but a deeper look underneath the hood makes it obvious that both firms have different (perhaps very different) sources of business risk. This can serve as an instructive example for investors: When it comes to analysing risks, the devil is often in the details. It applies as well for investors looking at different companies and their respective industry peers.

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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 writer Chong Ser Jing doesn't own shares in any company mentioned.