$APT (Alpha Pro Tech) is a 40 year established seller of disposable PPE and woven building materials. $APT saw enormous growth and success in 2020 at the height of the pandemic. Their long predictable $45 million annual revenue more than doubled to over $100 million in 2020. Naturally as pandemic PPE supply caught up as demand softened, $APT gave back some of that growth and has seen sales of $55.5 million for Q1-Q3 of 2021 and $84.5 million on a trailing twelve month basis. The market has not been kind to the stock and they sit near a current market cap of $80 million with just over 13 million shares outstanding:
While a quick glance might suggest this is a company reverting to its pre-pandemic revenues and share price, a deeper look suggests that thesis priced in by the market is a gift to diligent investors like yourselves who study what is really going on under the hood. Let’s break out the bull case for $APT:
PART 1: VALUE
Pull up a snapshot from any market data aggregator and you’ll see some of the hallmarks of a value play: P/E of 6.1, no debt, near 52 week lows etc. If we pull back the curtain and dig down, that value proposition may be even stronger than it first appears. I’ll focus purely on the balance sheet here and look at income potential in Part 2.
Reference the Balance Sheets on Page 1 of Q2 and Q3 filings:
Q2 2021 Filing
Q3 2021 Filing
First, take in the book value (assets minus liabilities) as of Q3: $62.7 million. This represents the accounting hypothetical value if the company were to shut down tomorrow, pay off everything they owe, and liquidate everything they own. No future cash flows, no growth, nothing looking to the future. It’s like calculating your net worth if you were to die tomorrow and your heirs were crackheads that pawned everything for a few weeks of speedballs. Already with this hyper pessimistic scenario, we have accounted for a valuation of $4.67 per fully diluted share ($62.7 million / 13,419,485 diluted shares) in a shut down and liquidate scenario. But APT isn’t shutting down or liquidating. Is there more present-day-shareholder-meaningful value than what the accountants are allowed to recognize on the balance sheet?
Hell yes there is! Here are a few examples where $APT would find some:
They held $23.2 million in inventory at last report. But that doesn’t translate to $23.2 million in cash after this inventory is sold. Remember from GAAP: inventory must be carried at the lower of cost or expected net realizable value. We can infer from management comments that the bulk of this inventory is in the mask and PPE segment and not building supplies and wraps (where they are expanding capacity because they can’t keep up with orders). PPE is a much higher margin segment for $APT. Gross margins on PPE have been close to 50%, but lets apply the pre-covid 35% margin for some realistic conservatism. The cash that inventory will be converted to when sold: $23.2 million * 1.35 = $31.3 million conservatively estimated future cash flows from existing inventory. That is $8.1 million over crackhead book value. Another $0.60 to give us $5.27 per share so far.
Isn’t covid waning and they might need to steeply discount or write down that inventory when they can’t sell it?
Probably not anytime soon:
Not enough covid FUD for your tastes? Well, look here at Omicron impact and new variants on the horizon:
If businesses close and airlines have staffing shortages due to covid, a logical leap would be an emphasis on protective equipment to keep these institutions operating.
Alright, Inventory was fun. But wait until you read about:
Equity Investment In Unconsolidated Affiliate:
“The number barely changed from last year. That’s probably just accounting buzzword salad for some bullshit no one cares about” – Every analyst that missed this
What the hell is this thing anyways?
This indicates an ownership (investment) in another firm (affiliate) that is less than a 50% stake (unconsolidated) but greater than 20% (you don’t use the equity method if less than 20%).
$APT owns a chunk of another company? Head back over to the Q3 10-Q filing from the link above and go to section 7 (bottom of page 8).
“In 2005, Alpha ProTech Engineered Products, Inc. (a subsidiary of Alpha Pro Tech, Ltd.) entered into a joint venture with a manufacturer in India, Maple Industries and associates, for the production of building products. Under the terms of the joint venture agreement, a private company, Harmony Plastics Private Limited (“Harmony”), was created with ownership interests of 41.66% owned by Alpha ProTech Engineered Products, Inc. and 58.34% owned by Maple Industries and associates….In addition, the joint venture now supplies products for the Disposable Protective Apparel segment.”
Translation: $APT has the domestic manufacturing facilities we know about but also deeper under-the-radar vertical integration with 41% ownership in their largest offshore supplier. Vertical integration meaning $APT owns or holds a large stake in everything from the procurement of raw materials overseas all the way through to sales to their domestic customer. That’s a leg up on the competition for the next few years while supply chains are shit.
Why $6 million on the balance sheet today? Once again, GAAP forces you to carry it at the lowest possible number. Carrying value is their initial investment ($1,450,000) plus a 41% share of net income. Based on the run rate growth on the balance sheet, $APT’s share of Harmony’s net income is at about $800k per year. A 10-15x multiple on those earnings is already much more than the current $6 million on the balance sheet.
But do you think Harmony sells to $APT, a 41% owner, at full list price? Of course not! Harmony’s net income is undoubtedly trimmed by sweetheart deals for their largest customer and 41% owner. Has Harmony ever told $APT “Sorry, we booked all of our capacity for other customers” or handed $APT a stack of red tape to fill out for a defect or error with an order? Hell no! There are synergies and benefits that $APT gets to reap every single day from this partner. But they don’t get to recognize those expected future benefits on the balance sheet. So how do we value this stake? It is subjective but even if liquidated to a competitor, it sure as shit would be a hell of a lot more than $6 million given the nearly $1 million share of annual income + all of the other benefits. It’s perfectly reasonable, imo, to tack on another $1.00 per share to the balance sheet of $APT based on this ownership.
So we’ve got $4.67 per share in crackhead value + $0.55 in semi discounted inventory already on hand + $1.00 from a sweet partnership that they can’t fully recognize. That’s about $6.20 per share, a premium on the current price. Let that sink in: the current share price is probably undervalued if all they did was sell off their existing inventory, divest their Harmony stake, then shut down and get high all day.
But Jay and Silent Bob don’t run $APT and $6.20 isn’t the final fair value. Let’s look to the future to see what lies ahead for $APT to layer more value on top of that liquidation scenario.
Part 2: Growth
I think we all agree: $APT has passed their pandemic sales peak for PPE. But is covid done juicing these beaten down shares? Maybe not.
In the inventory section above, there is plenty of evidence to suggest that a new baseline of PPE sales will remain materially higher than pre-pandemic levels with research reports suggesting a new normal where we get back to positive industry growth from 2021 going forward. Add the Omicron surge of the last month and new mask mandates and there is reason to believe we might see some new life from that segment. But don’t take my speculative word for it. Read this excerpt from the CEO of a PPE competitor $LAKE. He had this to say on 12/9 for the earnings call for their quarter ending 10/31 (weird corporate calendar):
Previously, we anticipated that COVID driven sales would continue to diminish quarter-over-quarter as the pandemic ran to its conclusion. But this is not the case in Q3. Third quarter fiscal year ’22, COVID 19 sales were an estimated $6 million or 20% of revenue, compared to our second quarter fiscal year ’22 COVID sales of $3.5 million or 13% of revenue. This is a significant deviation from our expectation for a continuous decline in pandemic related sales*.”*
$LAKE has a significantly different geo mix of covid PPE sales compared to $APT. I would not count on $APT beating by 70% as $LAKE did. But it could be a sign of a wider bouncein this industry, or at least a slow down in the projected declines.
$APT may have tipped their hand with the announcement of the expansion of the buyback just before the end of the 4th quarter. Could better than expected PPE revenues coming in for Q4 (like $LAKE saw) have influenced getting that expansion of the program started while the share price is low before the next earnings release stirs the pot? We won’t know for sure until the annual report drops. But the tea leaves have me looking forward to the next earnings release. Any PPE related tailwinds in the near term are going to help add fuel to the expansion of the segment of the business: Building Supplies.
$APT’s bread and butter has been PPE for years. But it’s the woven building supply segment that opens up longer term value for shareholders. Historically a smaller percentage of sales on thinner margins, building supply has come to life over the last year with margin expansion to support it.
$APT is nice enough to break out not only segment sales but also segment income with costing allocated to each line of business. The last few years look like this for the building supply business:
Several run rate scenarios around the recent growth rates for segment income yield some eye opening numbers when we think back to the ~$80 million market cap we see today:
$10-$15 million or more in annual segment income within the next 2-3 years? Discounting that cash flow at 10% still gives a present value of between $25 and $35 million to this line of business just for operations over the next 3 years. Perpetual values are a shot in the dark without knowing where margin expansion or faster growth rates could top out, but probably land between 3x and 5x of these values. That is a $80-$150 million valuation range on just the building supply segment. That’s $6-$12 per fully diluted share if you are keeping score.
Are those growth rates sustainable and is $APT prepared to scale up to deliver that kind of growth? Management seems to be 100% on board from the last earnings release:
“We continue to be optimistic regarding our expectation for continued growth in future periods and have committed to increasing production capacity for the Building Supply segment by investing approximately $4.0 million in new equipment, part of which became operational in the latter part of the third quarter of 2021 and began to contribute to the record sales quarter. As a result of a delay in the supply chain, the most expensive piece of equipment is now anticipated to arrive in the latter part of the fourth quarter of 2021 and is expected to be operational in the first quarter of 2022, which will add additional capacity for future growth”
For reference, $APT historically has spent $2.0-2.5 million on CAPEX per year. They just dropped $4 million on equipment that is coming online as we speak to power the expansion of the future of this business. They are all in and don’t give a shit what you think about it. Maybe those segment growth assumptions above will turn out to be conservative…
Fair Value Scoreboard (so far):
Balance sheet today: $6.20 per share
Building supply segment: $6-$12 per share
PPE segment: $1-$5 per share (a guess depending where covid takes us, call it $0 if you want)
Fair Value Range: $13.20 to $23.20 per share (120% to 388% upside)
Part 3: Buybacks are Religion at $APT
We’ve looked at valuations so far through the lens of 13.4 million fully diluted shares. However, there is one thing $APT has always done and probably always will do. Burn shares like a post IPO biotech small cap burns cash. 2012 started with over 21 million shares outstanding. Pre-covid, during covid, post-covid, doesn’t matter. If they’ve got working capital where it needs to be, they’re using the rest of their cash to buy back shares. Book it.
Don’t expect this to change anytime soon. Despite all the price action over the last year while holding 1.5 million shares, the board and C-Suite have barely sold anything over the last year.
This recent price drop to sub $6 has been a gift to the buyback program and the board knows it. As mentioned above, they just added another $2 million to the buyback tranche on a day that the market closed at $5.35. If history is any indicator, they have probably aggressively spent a good chunk of that allocation in just the last few weeks as prices hover around 52 week lows. This allocation could eat away 300k to 400k shares from the outstanding count. I estimate that we will see share counts of approximately 13.1 million fully diluted with 12.8 million outstanding when the most recent counts are disclosed with the next filing.
So go ahead and tack on another 2-3% on our per share valuation today because these babies are drying up like Lake Oroville. While a foregone conclusion that a new buyback allocation will be approved and declared, probably in the next few quarters, its impact will be limited by the share price at the time that the funds are deployed. So let’s stick to 3% total adjustment on our valuation with emphasis on the very opportunistic move in December but know there is gravy here.
Share Count Adjusted Fair Value Range: $13.60 – $23.90.
Part 4: Shorts will fall on their swords
Sorry, but it wouldn’t be Reddit without some squeeze talk. If you buy half of what I’ve dropped here so far, you might be surprised to learn that short interest is rising quickly with these positive catalysts lurking.
Shorting has been beaten to death over the last year, so I’ll keep this quick.
$APT has been building short interest up in to the double digits percentages on its way down to near the 52 week low (which is close to book value). The last time $APT caught a little tailwind on some volume, shorts doubled down hard and smashed the rally.
Shorting a rally happens all the time. Why is that of interest for $APT and why should you see this as bullish?
For one, you’ve got the backdrop of the balance sheet that will support prices near current levels. Additional shorting at this price is like trying to short a SPAC at its $10 NAV. Second, is something called the maintenance margin requirement. You might have heard a lot about the direct incurred when borrowing shares. But there is another component associated with shorting, the cash you have to hold on hand to back up your short play. These rates for $APT are through the roof! Most stocks sit at a 100% requirement, but $APT maintenance rate is 200% on IBKR and 300% on Fidelity. That is not just opportunity cost for putting cash on the sideline. It is also a big margin call risk. As the price of $APT increases, the margin required to back up the position rises multiple times faster than a typical short position. Now the 10-12% estimated short interest punches above its weight.
Check out the shares on loan and other SI data over the last few trading days where the last rally was shorted back down. They fought the rally starting 12/27 by shorting 5% of the float TO DEFEND BOOK VALUE AT 200-300% MAINTENANCE REQUIREMENT. Poor decisions were made:
Any attempt to fight back on the next rally risks drying up the few shares remaining to borrow and could trigger a spike in cost to borrow shares and a full on squeeze.
Part 5: The options chain is LOADED after last week’s action
Check out that volume for the big price swing days in Part 4 above. Shit got moving for a few days before the shorts fought to knock it down. And what do retail investors do when they chase a stock? That’s right, they load up on OTM calls!
For the savvy investor, such as yourself, this is great news! Now that prices have found support at pre-rally levels for a few days, the IV and premiums on options have come back to the same entry points you thought you missed last week. And even better: the open interest from the volume last week hasn’t churned out. The options chain is coiled with open interest that wasn’t there during round one. How often do you get a second chance like this?
And where do we see that open interest? Near the money calls that expire January 7th and 21st. The delta slope implied by these gamma values is THICC:
Delta and gamma can fluctuate wildly, especially as you approach expiration. I’ve taken the greek values from CBOE which are slightly different from what my exchange showed above, to the conservative side. This implies over 700k shares already hedged on just the call contracts selected below.
Those gamma values are starting to climb as we approach expiration with just these contracts requiring another 5,000 shares to hedge against a $0.01 move in the price. Like I said… THICC.
The promised TLDR;
$APT is a value play – Their balance sheet alone is worth at least as much as the current share price especially after you dig in on the make up of their inventory and their joint venture with Harmony.
$APT is a growth play – Covid may have one last run that pushes some high margin PPE revenue for $APT. More importantly, the building materials business is starting to take off. A discounted cash flow analysis shows this segment of the business alone could be worth $10 or more today. If we stop here, my DCF analysis gives a fair value range for $APT of $14 to $25 based on a range of plausible scenarios. But we’re not stopping here:
$APT loves its shareholders – The board and executives love to buy back stock because they love to accumulate stock. They have been buying back shares like clockwork for over 10 years and have killed 40% of the shares that existed in 2011. They are dialing up the buy back while prices are low to eat away more shares and shares outstanding are likely approaching 13 million flat. The chances of an equity offering or large dilution anytime soon is virtually 0.
$APT was shorted by masochists – Last week’s sudden pop in short interest to defend a ridiculously low price with high maintenance margin was probably a bad call. There is little runway left for further shorting without risking a full on squeeze. At worst, the SI will be an unwind that helps push the price above the current near-book-value levels. And the best case: Things get squeezy.
$APT had its option chain loaded up for expirations right around the corner – The OI/Delta/Gamma dynamic looks vulnerable. Especially for January 7th, just a few days to expiration. MM hedging against even a modest price run could start some violent price action.
Conclusion: $APT as a squeeze, a swing, or a decade… You’ve got a good chance of being happy with the outcome.
I am not your financial advisor. I do not know your specific circumstances and risk tolerance. Otherwise have fun!