- Alpha Pro Tech has been a monster of a momentum stock.
- After cooling off the past couple of trading days, the company is still overvalued.
- Primed to fall 30% even under best case scenario.
Although the looming threat of a COVID-19 pandemic has demolished stocks all across the index last week, there were a few lucky beneficiaries for whom this crisis was their time to shine. One such stock was Alpha Pro Tech (NYSE:APT), a small company that produces personal protective gear for medical professionals. During a week when the S&P 500 dropped nearly -10%, APT rose +250%. Since the start of the outbreak, APT has transformed from a $45 million company into a $200 million company. At peak valuation, achieved last Friday morning, APT was worth a staggering half a billion dollars.
It has cooled off since then, ending Friday with an overall loss. Is the party over, the hype train dead? Investors (speculators?) who bought at the top are no doubt feeling the pain, but the worst may be yet to come. It's true that as a producer of personal protective equipment, APT is uniquely positioned to reap massive financial rewards from the coronavirus, but after running the numbers, the only conclusion I could draw is that even in an ideal scenario, APT is not worth the price it's trading for now.
Let's talk about the coronavirus for a moment...how bad can it get? The CDC's official position is that it's not a matter of if, but when the virus spreads to the US. Harvard epidemiologist Marc Lipsitch claims there's a possibility that 40-70% of the world population will be infected by the end of the year. The consensus seems to be: yeah, it might get pretty bad. However, if history offers any lessons, it's that even the worst pandemics rarely last more than a year. The Spanish Flu of 1918, widely acknowledged to be the worst pandemic of the century, began in March of 1918 and was largely over by the summer of 1919. The swine flu pandemic of 2009 began in March of 2009, started tapering off in November of the same year, and had run its course in August of 2010. Chances are good that no matter how bad it gets, COVID-19's social and market impact won't endure beyond 2020, which means APT has precisely one year to make as much money as it can before the golden opportunity disappears.
The task before us is now simple: to calculate how much money APT might make in an ideal scenario where everything goes right. Currently, the biggest cash cow for the company is the N95 mask. People are stockpiling these masks either for their own families or to send overseas, stores across the country have run out of inventory, and scalpers on eBay have driven the prices up 1000%. According to APT, their margins for this product are significantly higher than their overall gross margin, and they've announced that since January 27, they've received $14 million in orders for N95 masks. Previously, they were only making about $500,000 annually from this product, and they're currently heavily ramping up production to be able to meet the huge spike in demand.
According to the company's press release, it'll take them two quarters to be able to fulfill the backlog of orders for the N95 mask, with a production capacity of $4 million in Q1 and $10 million in Q2. Let's assume that APT continues to ramp up production in the next two quarters and the demand is there to absorb all the new units they produce: they deliver $15 million in masks in Q3 and $20 million in Q4. That's a net gain of $48.5 million in revenue for N95 masks alone. Apply a 60% gross margin multiplier (APT's gross margin for all products is around 35%), and they are looking at adding $29.1 million in operating profits.
However, the N95 mask is not the only product APT sells, only their most lucrative one. They also sell regular surgical masks and face shields, which is normally a $4.5 million per year business for them, excluding the N95 line: see their 2018 annual report. Their disposable protective apparel segment, which consists of products like isolation gowns and boot covers, is a $15 million business. Finally, half their revenue in prior years came from their building supplies segment, worth $26 million in yearly sales.
We can ignore the coronavirus impact on their building supplies business. Their other two segments wouldn't be nearly as lucrative as their N95 line: surgical masks are a low margin commodity product that's easy to manufacture, and protective apparel will only see additional demand from medical personnel rather than the general populace at large. Figure they 10x their non-N95 mask business, and 5x their disposable protective apparel business: that's an additional $41.5 million in operating profit after applying a generous 40% gross margin.
That brings us to a total of approximately $70 million in additional operating income for 2020, or $56 million net profit after taxes. We'll be generous and give APT half of that for 2021 as sales ramp down, production capacity is reduced, and demand for specialized medical equipment normalizes. That brings us to $84 million in cash value that a COVID-19 pandemic would add to APT's balance sheet by the time the storm passes in a year. Their market cap was $45 million in December of 2019, before the first reported outbreak in Wuhan, China. At most, they should be worth $129 million post-coronavirus, if they capitalize perfectly on the opportunity and all the financial stars align for them. As of Tuesday premarket, they're currently trading at a market value of approximately $180 million, indicating that shareholders are likely to see a 30% decline in their position even in a best case scenario.
And remember: this is a best case scenario for APT (financially). The pandemic may not occur after all, with efforts to contain it proving successful. They may be unwilling or unable to ramp up mask production after Q2 of this year, as excessive investment in permanent manufacturing capacity can prove foolhardy for a temporary disease outbreak. Margins may be driven down from increased cost of raw materials due to a spike in global demand and increased overtime pay for workers, and overhead may go up from hiring additional laborers and support staff. They might lose money after the coronavirus winds down as a result of capacity expansion overhead meeting extinguished product demand. In all likelihood, APT will be worth far less than the $129 million valuation they would have in the ideal scenario, and even if the stars do align for them, the current price is still almost 40% higher than where it should be and existing shareholders stand to see their capital destroyed once the momentum for this stock runs out.
When APT was half a billion dollars, this was a magnificent short, and now, it's still an okay, if risky short, and terrible long. For those prescient investors who bought in before APT transformed into a poster child hype stock surfing the wave of coronavirus panic: it may be time to cash out your gains after a great, wonderful ride.
This article was written by
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