Earnings and Riverstone Holdings Limited

“A lot of money managers today worry about quarterly comparisons in earnings,” he said. “They’re up biting their fingernails until 5 in the morning. My dad never worried about quarterly comparisons. He slept well.” Walter Schloss

I do hope I can buy at a point whereby I can sleep well no matter what happens. As years go by, I tend to prefer the peace of mind rather than excitement of profits. Nevertheless, I have looked at the recent full year earnings of some of my holdings. Some are expected good news: Vicom, Riverstone, ISOTeam & SMRT. Super Group seems to be gaining some momentum upwards (what is surprising is the better than expected quarterly profits). CapitaLand surprised me (but then it is mainly due to Westgate). While SIA, Sun Hung Kai Properties and Golden Agri did not do well. The latter poor performance is expected.

Actually most of the times, I kind of like left SMRT and SIA in the “stocks to remind me of my mistakes” basket. Although I consider myself a bottom-up investor, I can sense that world economy is still soft. The cyclical companies are struggling. That in my view is a good thing. There are still opportunities to be made. However it is just a feel with no real logic.

I like to read up on great investors (books or websites): Benjamin Graham, John Templeton, Warren Buffett, Charlie Munger, Peter Lynch, Walter Scholss, Irving Kahn, Max Heine, Micheal F Price, Bill Miller, Eddie Lampert, Seth Klarman, Kenneth Fisher (and his dad Philip Fisher), and to a lesser extend Jim Rogers and George Soros.

I didn’t have much time to research on companies, and the way I do is to read news or blogs and wait for “good companies” to appear. It is not hard to find commentaries about good companies, but it is harder to wait for the right price. And rarely you get bad news that will make good companies drop drastically. Often it is bad news that make mediocre companies’ share price drop (eg. Olam vs Muddy Waters and recently Noble vs Iceberg Research). However, I am not really keen on buying mediocre companies, and even less keen on bottom fishing stocks of big complex companies which I don’t understand well. One Golden Agri is enough for me :p Even Peter Lynch who has a very pro-active approach to investing mentioned that there is always no hurry to buy stocks (and jokes about people who rushed to ask him to buy some hot stocks. So rushed that they sound breathless on the phone). You have plenty of time to identify and recognize exceptional companies. Lynch mentioned that Wal-Mart was a 10-bagger — i.e. its stock rose to 10 times its initial price — 10 years after it went public. Even if you had gotten in after waiting a decade, though, you’d be sitting on a 100-bagger.

A lot have been written about the good companies such as Vicom, Raffles Medical, NeraTel, Riverstone Holdings Ltd, Colex, Super Group, Japan Food, Boustead, Straco, ISOTeam, Hosa International Ltd (HK), Luk Fook Holdings (Intl) Ltd (HK), Man Wah Holdings (HK), Real Nutriceutical Group Ltd (HK), etc…. Well, of course we can debate on which are the good companies, but in general most of these companies have low or zero debt, high growth, and favorable narratives.

I always remember the few times when I heard the phrase from older folks saying “that the candy shop is open” – that is when you know the market has plunged badly and that there is value to be found. I still find it a cute way to describe about something so morbid (esp when I look at my portfolio at night and it looks like a murder crime scene- bloody red).

Well the time has not come…yet.

Let’s talk about Riverstone Holdings Limited.

Riverstone manufacture, source and market mainly nitrile and natural rubber gloves primarily for use in a class 10 and class 100 cleanroom environment. (I have previously blogged about why I bought Rverstone. Read here).

One particular post by CIMB about Riverstone piqued my attention (also read here). No doubt the 4Q14 results were good, but why the downgrade? If the earnings as stated by NRA and OSK DMG is above their expectations (read here and here), why did CIMB downgrade it to sell from hold? This is a company that has expanded and is running at full capacity.

“I think you have to learn that there’s a company behind every stock, and that there’s only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies.” – Peter Lynch

I have previously calculated the intrinsic value of Riverstone and felt that at current share price, it is not undervalued. However,I would have expected analyst to raise their forecast and fair value once good results are out.

CIMB cited that Riverstone’s healthcare segment is unlikely to benefit from the stronger US dollar and lower raw material, given the stiff price competition in the segment.

Well, after reading the discussions in the Valuebuddies forum, the key points mentioned:

Strong USD beneficial to Riverstone (since their sales are mostly in USD). USD will likely to increase in value against Malaysian ringgits (Riverstone cost).
Question about the duration of the benefits of lower taxation (tax incentives for the new plant).
Rubber price has been crashing past few years, and may rebound, hurting Riverstone profits.
Riverstone sells direct to customer. Hence resulting in higher margins and gaining a good understanding of the customer needs.

I found another site that talks in details about Riverstone very useful and in particular, the strengths, weaknesses, opportunities & threats about the company (See below):

In comparison to its competitors, Riverstone(RS) ROE is higher than Supermax (after 2010) and more constant (at 20%) due to RS zero debt and efficient management. RS also has the highest ROA as compared to Kossan and Supermax. However, RS gross profit margin is the lowest. Nevertheless its ROE is ranked 2nd and the rubber glove manufacturing industry is relatively stable ensuring profits stay stable.

Interestingly they estimated that the share value of Riverstone to be $2.82 using FCFF method.

Well, interesting reads. Let’s look under the hood. When I compare the full year results in 2012, 2013 & 2014, undoubtedly the results are getting better, but the growth is slowing.

EPS (SGD)

2014: 0.07240 (Change from 2013 to 2014: 20%)
2013: 0.06034 (Change from 2012 to 2013: 41%)
2012: 0.04275

Revenue Growth

2014: 9.393 %
2013: 11.514 %

Net Earnings Growth

2014: 19.994 %
2013: 41.125 %

Return On Equity (ROE)

2014: 19.096 % (Change from 2013 to 2014: 6%)
2013: 17.970 % (Change from 2012 to 2013: 15%)
2012: 15.573 %

So back to CIMB’s claim:

De-rating catalyst of the increasingly challenging industry landscape due to overcapacity. The potential overcapacity in the healthcare segment remains an overhang.
RS unlikely to benefit from the strong US$ and the decline in raw material prices.

Frankly I think a lot of the strengths of Riverstone are still intact (disposable & inexpensive gloves, niche market and meet customer needs) and new developments (rising USD, low rubber cost) are to their advantage.

eg. Cost of RS Safe Blue Nitrile Exam Glove:

U.S. Dollar 19USD/CART
100 gloves per dispenser box and 10 dispensers per carton
0.019USD per glove.

As for the oversupply of gloves, I think the strategy of meeting customer’s needs is still intact. (read here)

They don’t have to be in a growth industry, but they do need a winning repeatable formula that has proven itself in more than one location and still has room to grow. Peter Lynch

Nitrile gloves contribute like >90% of Riverstone Revenue. Nitrile prices are a lot less volatile, and production techniques continue to get better. Since nitrile is a man-made product, the production is not as subject to the whims of Mother Nature as latex. (Read here). So I really wonder how much impact raw materia fluctuation has on nitrile gloves. That is not really much of a consideration.

And with regards to USD rates – I can only foresee increase in USD to Malaysian Ringgit rate (which is beneficial to RS). The era of low interest rates / QE in US has ended. The US economy is picking up unlike the rest of the world, why would they lower rates so soon – after so many rounds of QE?

Again Peter and Warren would have liked Riverstone because their products are low-tech, easy to understand and disposable (repetitive nature of the product that is relatively immune from technological obsolescence and recessions). Interestingly someone even says RS is a wonderful company at a fair price. (borrowing a quote from Warren) Unfortunately, I don’t use their nitrile gloves.

“Know what you own, and know why you own it.” – Peter Lynch

Riverstone Posts 22.4% Growth In Net Profit To Record High RM71.0 Million In FY2014.
The company intends to add capacity for another one billion units by end-2015, bringing total production capacity to 5.2 billion gloves annually.

Looking at the above that is another approx. 20% increase in capacity going into end 2015. Hopefully it will translate into another 20% increase in profit.

It is a stock that I may considering buying on big dips or corrections. I still trust my calculation of intrinsic value (0.5) and trailing PEG of RS (1.0) and think the share price is overvalued.