RIVERSTONE HOLDINGS reported record quarterly profit in 3Q2013 of RM15.7 million on improved gross margins related to favourable raw materials prices and greater productivity.
Gross profit margin was 26.8% for the nine months of 2013 compared to 23.1% for the entire year of 2012.
The 9M net profit was RM42 m, which already exceeded the full-year 2012 figure of RM39.7 million and its full-year 2013 profit is set for an all-time high.
Riverstone has been positive free cash flow since its listing in 2006 -- which is some achievement considering that it has been expanding production capacity.
Its earnings have been driven up by capacity expansion from 720 million gloves in 2006 to 3.1 billion gloves by end-2012.
The rate of utilisation in 3Q this year was about 91%.
Riverstone is estimated to have a market share of 60% of the world's cleanroom glove market, as it is the main supplier to the big boys of the hard drive and semiconductor industries -- Seagate, Western Digital, Hitachi, Toshiba, and TDK.
The following are questions raised at an analysts' briefing last week and answers provided by Riverstone executive chairman Wong Teek Son and CFO Lim Sing Poew.
Q: What is the volume breakdown for the cleanroom and healthcare gloves segment?
A: In terms of revenue, the contribution from cleanroom and healthcare gloves is 50% each and in terms of operating profit, cleanroom gloves’ profit is double that of the healthcare gloves. In terms of GP, it is about 30% for cleanroom gloves and 17% for healthcare gloves.
Q: Has the ASP for your gloves changed over the last quarter?
A: There were no changes in the selling pricing of our cleanroom gloves but healthcare gloves are subject to raw material price fluctuation. We adjust the selling price monthly in accordance to raw material price. Since rubber price had been on the downtrend, we have had to reduce our selling price for healthcare gloves by about 2-3%.
Q:How has the raw material prices changed for 3Q2013 compared to last year?
A: Raw material prices are actually on an upward trend and prices have increased by about 3-5% which brings it to the normalized price range.
Q: In terms of healthcare gloves, is there a lot of customization that needs to be done?
A: We see increased demand for customization work for healthcare gloves as there are many suppliers out there, which lead to more choices being offered to customers. As such, distributors are also looking for customization to be more competitive. Everyone is working to create new solutions for the customers.
Q: Can you share about the increase in staff costs?
A: We incurred staff and admin costs when we implemented training programmes. This was due to an overall growth of the company, in terms of revenue and also of minimum wages. We also have a profit sharing scheme which contributes to the increase in pay-roll. The basic wages for our employees increased by about 10% as compared to last year.
Q: Why is there a shift to nitrile gloves for the healthcare sector?
A: Nitrile gloves perform better in terms of functionality and there are also cost factors. In terms of comfort, it is also comparable to latex gloves.
Q: What is the percentage of gloves that you sell direct to customers and to distributors?
A: For cleanroom gloves, we have our own brand and sell directly to our customers except in Japan, Korea and US. For healthcare gloves, we only sell to distributors.
Q: Do the healthcare gloves distributors represent you exclusively or can they represent other brands too? Assuming that the gloves are sold at the same price, then how would they have a greater incentive to sell a particular brand?
A: They always represent two to three glove manufacturers. There are many categories of customers. Some prefer the standard types while others prefer the customized versions.
Q: Are Scandinavian country customers more price- or quality-focused?
A: Quality always comes first for these are PPE gloves. CSR (corporate social responsibility) also plays an important aspect. We can charge a slight premium but the deviation should not be too much.
Q: What is the percentage of cleanroom gloves for the mobile segment?
A: About 20 plus per cent. We have Riverstone Wuxi in China which supplies directly for the mobile and tablet industry in China.
Q: Has your ASP to Seagate declined?
A: We negotiate cleanroom gloves pricing half yearly or annually.
Q: How do you manage your forex exposure?
A: We sell in USD and lock in the exchange rate upon confirmation of sales. We usually refer to the beginning of the month as a guide for the forex rate.
Q: Are there difference in margins for different types of healthcare gloves, such as surgical gloves?
A: Yes, there is a significant difference. The profit margin for surgical gloves is much higher but we do not produce them at the moment.
Q: What are the tax incentives you enjoy from the government?
A: We have reinvestment allowance whereby it is an incentive from the government to reinvest a % of the CAPEX spent. You will for instance take a 60% tax incentive while there is still a 25% tax rate.
Q: What is your effective tax rate?
A: It depends on how much we earn and spend and may vary accordingly. In 2008/2009, our tax rate was about 10% as we invested a lot. We can only choose export or reinvestment allowance and we typically choose the latter.
Q: What caused the improvement in your margin in the last two years and whether it is sustainable?
A: External factors: Strengthening of USD and favourable raw material costs. Internally: Our higher utilization rate to existing 91% and our sales volume increased by 31% yoy. As a result of both external and internal factors, it led to the overall improvement.
Q: How do you adjust your ASP with respect to the raw materials price?
A: For the healthcare gloves, we have our own formula to calculate and we make price adjustments on a monthly basis in accordance to raw material pricing fluctuation. The general understanding is that we fix the ASP, but the increment depends on various factors such as consideration for our distributors i.e. whether they are able to market and sell the products.
Q: In the event of oversight or sabotage in QC issues for the cleanroom gloves, do you think your competitors can enter your market? Or would you expect defend your 60% market share?
A: When a situation of QC issue arises, we will meet up with the customer to address the concern. Customers are not prone to switch suppliers easily. There are inadvertently quality control issues but the best course of action is to resolve it and provide a solution to our customers soonest possible. We have strong relations with our existing customers and to date, we have not experienced such issues. We are confident of retaining our market share despite any QC incidents.
Q: From a supply chain management approach, would your 60% market share be too concentrated?
A: Many customers have this same query but when they conduct their audit on our plants in Malaysia, Thailand and China, they are comfortable and confident with the structure whereby we have a few production facilities and are not concentrated in just one plant.
Q: How long would the testing time take for customers if they want to consider changing suppliers?
A: For healthcare gloves, it would take about two to three months while for cleanroom gloves, customers are reluctant to switch. The minimum testing time is about five to six months.
New plant in Taiping
Q: How do you foresee the uptake of increased supply when your new plant is in place? Will you start to look for customers then?
A: Most customers have two suppliers with the distribution ratio of 60/40% or 70/30%. At present, we are only supplying 10-20% of our customers’ demand as we are unable to produce enough with our current production capacity. The pricing is right and there is a demand but we lack the excess capacity to supply.
Q: With the increased supply, have the customers already booked those orders?
A: The orders are visible but they have not booked them yet.
Q: For your new expansion, how many per cent are you allocating to cleanroom and healthcare gloves production?
A: While we prefer to allocate more to the cleanroom gloves as it commands a higher margin, the growth is much slower compared to healthcare gloves. It also takes a longer time to secure a new customer. However, the production lines are interchangeable. Whenever we receive more cleanroom gloves order, we will switch the production lines to manufacture more cleanroom gloves.
Q: As you enter into the lower end cleanroom gloves segment, technically you could ramp up production to produce more of the higher margin gloves?
A: Yes, theoretically. While we fulfill many of the technical requirements such as anti-corrosion, there are aspects of which we seek to improve such as useability and comfort levels. We still need to fine-tune the product.
Q: Do you expect to incur more expenses when you commission the new production lines?
A: We will incur some, but the costs would not be significant. When we commission the production lines, we are familiar with the design and would know where the possible problems might lie. As such, it would not be too difficult for us to make minor modifications to fine-tune the process. We do not expect to make major modifications and incur large costs.
Q: Can you provide an update on the capex for this year as compared to the previous year?
A: We expect about RM80 million capex this year to cover the first phase of the expansion. It also includes the purchase of land and part of phase two. We should incur lower capex of about RM40 million for the second phase. This is due to the fact that when we construct the first phase, we take into consideration some of the basic infrastructure costs necessary for phase two.
Q: May I know what is the expected total expenditure for the new expansion plans?
A: For the whole 30 acre development, we expect about RM400 million subject to prevailing market conditions which may affect the overall expenditure but this will be the benchmark figure.
Q: How do you expect to fund your capex for the new expansion?
A: The first two phases would be via internal funding and looking beyond that, we would consider bank loans.
Q: For the new expansion, do you expect to be profitable from the start or expect to incur any start-up losses?
A: We start the production lines in phases and we only start to account for depreciation once we start selling the products. When the first line starts, the commissioning process will take up to two months and we will adjust for any minor modifications, hence it will not have any major impact on the EBITDA.
Q: How do you handle the challenging labour situation, especially with respect to skilled workers?
A: We have in place a middle level management and they are undergoing training. As soon as the plant is ready, we will have a ready group of middle level managers to supervise the operations. In terms of the actual ground work operations, we still depend largely on foreign labour. However, this new design that we implement for our production lines, it will be less labour intensive and focus more on automation.
Q: Who are your strongest competitors in the HDD and mobile segment of cleanroom gloves?
A: We are the sole supplier for most of the HDD manufacturers whereas the mobile segment is uncertain at this point since it is a new market. As such, no one company supplies the “perfect” glove. At present, we are focusing on a type of cleanroom glove that prevents corrosion which we believe can penetrate the market.
Q: How does Valutek measure up as a competitor? Can you share more about them?
A: We used to work with them but we had discontinued our business relations with them. As such, we are not familiar with their existing operations.
Q: Do you see Medi-Flex as a strong competitor?
A: Their previous strategy was to enter the cleanroom glove market, where they initiated about 10 years ago. We do not see them having competition with us at this point in time.
Q: Why does a giant company like Top-Glove want to acquire Medi-Flex? Are they developing into the cleanroom gloves segment?
A: We are not in a position to comment on the acquisition.
My understanding of the HDD market is that most of the HDD component suppliers use our gloves as their main concern is contamination. Our cleanroom gloves are not only quality assured but also meet their specific requirements. We have established a solid track record, which is very important in the cleanroom gloves segment. Many glove manufacturers attempt to enter the cleanroom gloves segment as it commands a higher margin but this market is not an easy one to penetrate.
We have been in the market for cleanroom gloves since 1995 and as we constantly seek to improve and work with our end-users. It is more than just meeting product specifications.
Q: With increased supply by various competitors in the market, do you expect a decrease in the ASP?
A: Some glove manufacturers are expanding more than they ar supposed to, therefore the only way for them to compete is on pricing. We are therefore trying to avoid entering this price competition. When we work with our customers, we compete in terms of quality and other factors. We invite our customers to our factories where they are able to witness the hygiene and innovation levels, welfare and safety of our workers.
These premium customers are primarily from Scandinavian countries which are our target. Their focus is largely on hygiene levels as they fear contamination to their products. We are therefore optimistic to compete based on these strengths of ours.
Q: I noticed one of your competitors, Hartalega, wanting to double their capacity to 28 billion by 2020. Do you foresee any pricing weakness over the next five years or will you expect the growth in the market to absorb this increased supply?
A: The growth is about 10-15% per year and every manufacturer is increasing their production capacity. We work with our distributors to first penetrate into the market before increasing our supply. We are currently only looking at increasing supply by 1 billion units per year. Our strategy is not to mass produce and outperform by volume but rather to expand and yet maintain our margin levels as we continue to develop customized product solutions for our customers.
Q: How do you compare and match up to other competitors? Are there any reasons why Hartalega is able to maintain its high margin despite its size? Is it owing to economies of scale?
A: Many people think that it is economies of scale but if you break down the costing of manufacturing gloves, raw materials and cost of labour are the two main elements, followed by utilities and chemical costs. It therefore only affects to a certain extent and not as extensive as thought. Hartalega is able to command such high margins probably due to their position being the first mover in the market.
Q: Do you expect to lose market share for your cleanroom gloves, where you are currently the market leader as more companies try to come into this business segment?
A: There is always competition in the cleanroom gloves industry as they had been around since 1990, such as Ansell. It is not only recently that we face competition for cleanroom gloves. For this sector, it requires constant improvement and innovation to keep up with the competition.
Q: What is your competitive edge for cleanroom gloves?
A: I believe it is due to our quality control and our significant advantage. Our products have better electrostatic charge control. Our gloves emit lower levels of electrostatic charge and this becomes increasingly important.
Q: Do you expect to maintain or increase your utilization rate? Also, will you keep up with current dividend payout ratio?
A: The current level is 91% and as we try to maintain such levels, it will be difficult to push it any further due to downtime constraints which occur as we have limited production lines. We only have 30 production lines therefore we have a high changeover rate whereby we will need to change our moulds upon finishing a particular production. This changeover time is very costly. As such, it would be good if we are able to increase our production lines so that we can better utilize our production capacity.
We try to maintain a 45-50% dividend payout ratio.