Unpacking Riverstone Holdings' Capital Efficiency and Dividend Sustainability: A Cautionary Tale for Long-Term Investors

Riverstone Holdings (SGX:AP4) has long captivated investors with its historically robust returns and generous dividend payouts. However, beneath the surface of its 14% Return on Capital Employed (ROCE) and 9.5% dividend yield lies a complex web of operational and financial risks that could undermine its long-term value creation. This article evaluates whether the company's capital efficiency and dividend sustainability are as resilient as they appear—or if they mask vulnerabilities that could destabilize its growth trajectory.

Capital Efficiency: A Deteriorating Trend

Riverstone's ROCE, a critical metric for assessing how effectively capital is deployed, has declined steadily from 21% in 2019 to 14% as of December 2023. While this figure still outperforms the 9.2% industry average for the Medical Equipment sector, the downward trend raises red flags. The company's capital deployment has become increasingly inefficient, with additional investments failing to generate commensurate returns. For instance, total assets minus current liabilities rose to RM1.8 billion in 2023, yet EBIT growth lagged, resulting in a “less bang for the buck” scenario.

The decarbonisation portfolio, a cornerstone of Riverstone's strategy, has been particularly problematic. Investments like T-REX Group, Our Next Energy, and FreeWire have been written down to 0.0x Gross MOIC, while Enviva's bankruptcy and Tritium's insolvency risks have eroded fair value by $41.5 million. These write-downs underscore the company's struggle to navigate the volatile renewable energy sector, where rising interest rates and fundraising challenges have compounded operational risks.

Dividend Sustainability: A House of Cards?

Riverstone's dividend yield of 9.5% is enticing, but its sustainability is questionable. The company has consistently paid out more than 100% of its earnings and free cash flow, with a payout ratio of 128% in the last fiscal year. This means it is distributing more cash than it generates, relying on cash reserves or debt to fund dividends. While its net cash position of $94 million (as of June 2024) provides temporary relief, this model is inherently fragile.

The disconnect between earnings and payouts is further exacerbated by the company's high dividend yield relative to its fundamentals. For example, the 10.9% yield in the past quarter far exceeds the sector average of 1.756%, yet the stock trades at a 39.9% discount to net asset value (NAV). This discount reflects investor skepticism about the company's ability to justify its valuation through consistent cash flow generation. Analysts project the payout ratio will drop to 90% over the next three years, but this improvement hinges on a return to earnings growth—a tall order given the decarbonisation portfolio's underperformance.

Operational and Financial Risks: A Perfect Storm

Riverstone's operational risks are multifaceted. The decarbonisation segment's struggles are compounded by macroeconomic headwinds, including geopolitical tensions (e.g., conflicts in the Middle East and Ukraine) and regulatory uncertainties. Meanwhile, the conventional energy portfolio, though performing better, faces its own challenges, such as supply chain volatility and shifting energy policies.

Financially, the company's liquidity position has deteriorated. Cash reserves fell from $291 million at the end of 2023 to $94 million by June 2024, partly due to a $200 million tender offer and buyback program. While these actions aim to reduce the NAV discount, they also constrain capital available for new investments or emergency buffers. Additionally, the performance fee structure for the Investment Manager requires recouping $94.5 million in losses before generating further fees, incentivizing riskier bets to meet targets.

Investment Implications: Proceed with Caution

For long-term investors, Riverstone Holdings presents a paradox: a high-yield stock with a history of compounding returns, but one now burdened by declining capital efficiency and unsustainable payout ratios. The company's ability to navigate these challenges will depend on its capacity to rebalance its portfolio, prioritize capital preservation, and align dividend policies with cash flow realities.

Key Considerations for Investors:
1. Rebalance Exposure: Given the decarbonisation portfolio's volatility, investors should assess whether the company can pivot toward more stable, cash-generative assets.
2. Monitor Liquidity: Watch for further declines in cash reserves and the impact of buyback programs on future flexibility.
3. Evaluate Governance: The appointment of inexperienced directors and lack of clear strategic direction could hinder long-term value creation.
4. Diversify Holdings: Avoid over-reliance on Riverstone's dividend yield, which is not supported by earnings or free cash flow.

Conclusion

Riverstone Holdings' high ROCE and dividend yield may appear attractive, but they mask a deteriorating capital efficiency and a dividend model that is unsustainable without significant operational improvements. While the company's recent capital return initiatives and conventional energy gains offer some hope, the risks—particularly in the decarbonisation segment—remain substantial. For investors seeking compounding returns, the lesson is clear: high yields and historical performance are no substitute for robust fundamentals. In Riverstone's case, the path to long-term value creation will require a recalibration of risk, a focus on cash flow sustainability, and a more disciplined approach to capital allocation.