Alpha Pro Tech: Coming Into Buy Range

Dec. 15, 2020 10:00 AM ETAlpha Pro Tech, Ltd. (APT)13 Comments
Robert Honeywill profile picture
Robert Honeywill
7.91K Followers

Summary

  • I have been bearish on Alpha Pro Tech, purely on excessively high share price.
  • The shares have come down by close to one-third since my last article, when I adopted a neutral stance, due to the considerable uncertainties as to projected sales volumes.
  • I believe the shares are now coming into buy range, but that still requires some assumptions that may prove overly optimistic.
  • Any commencement of large scale share repurchases by the company could be an indication of value.
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Alpha Pro Tech: Investment Thesis

Back on August 6, in my article, "Alpha Pro Tech: Performance Vs. Expectations, A Dose Of Reality", I wrote,

Prior to the Q2-2020 earnings release, even based on optimistic assumptions, the fundamentals did not appear to support the share price in the long term. Based on guidance in the 8-K filed on August 4, 2020, the company is now estimated to fall far short of those optimistic sales assumptions, at least in 2020. This only serves to reinforce the fundamentals do not support the current share price.

Since that time, the share price has fallen by about one-third, from $18.01 to $12.10. I have modeled the financials through end of 2024, and based on what might prove to be overly optimistic assumptions, my 1View∞Scenarios™ Dashboard indicates returns of 7% to 10% per year through end of 2024 might be possible. In September Alpha Pro Tech (NYSE:APT) approved $5 million in share repurchases, but only repurchased ~$280,000 shares in the month. I believe the management are smart about what they do, and the commencement of large scale share repurchases by the company could be a useful buy signal.

Alpha Pro Tech: Estimates of Incremental Sales Revenue for FY-2020 Updated

In my August 6 article, linked above, I included a table showing disposable protective apparel sales projections for 2020. The table is updated below with a comparison to the previous projections.

Table 1

Total Disposable protective apparel sales for the nine months ended September 30, 2020 were $51.0 million, which together with $22.7 million in Building supplies sales made up total sales of $73.7 million for the first nine months of 2020. Management's guidance contained in the Q3-2020 8-K filing dated November 5, 2020 is for:

  • Only $43 million of the $66 million orders for N95 face masks to be converted to sales in FY-2020. The expanded production facilities will have been available for the whole of fourth quarter. On this basis it would appear the expanded production capacity is ~$16.7 million in sales value per quarter, as orders are not a constraint on production. That equates to around $67 million in production/sales of N-95 face masks from current facilities in 2021.
  • Face shield sales in the second half expected to be less than the $5.8 million of sales in the first half. As sales of face shields were $4.2 million in the third quarter, this means sales in the fourth quarter are expected to be down to ~$1.2 million. Management explain there are low barriers to entry for new manufacturers of face shields, so depressed levels of sales can be expected to continue into the future.
  • Other PPE sales were restricted in Q3-2020 due to production disruption due to COVID-19-related shutdown of the manufacturing facility in India. Recovery in sales expected in Q4 unless there are further shutdowns.

The net result is total Disposable protective apparel sales are now projected to be in the order of $75 million for FY-2020. Taking into account existing pre-COVID-19 sales levels, projected incremental sales for FY-2020 are now ~$55 million for the year.

Alpha Pro Tech: Expectations for Incremental Sales Revenue for 2021

Available Production Capacity

From the Q3-2020 8-K filing,

We saw a dramatic increase in revenue from face mask sales throughout the third quarter, and we currently expect face mask sales to increase through the fourth quarter of 2020 and into 2021. In addition, sales of disposable protective garments and our Building Supply segment products saw year-over-year increases during the third quarter, continuing the trend from the first half of 2020. We also expect sales of these products to show continued top line growth for the remainder of 2020 and into 2021...and...Face mask sales have grown during each quarter of 2020. ...Management now expects that total mask sales for 2020 will be approximately $43 million. Based on current and anticipated investment in additional equipment and human capital, management currently expects face mask production capacity of $100 million in 2021 (including the increased production capacity from the previously reported phase 2 expansion).

I do not see the above as guiding for $100 million of sales of face masks in 2021. Rather I see it guiding for the business to reach $100 million face mask annual production capacity some time in 2021, versus present estimated annual production capacity of $67 million, as discussed above. Estimating sales for 2021 has now become more difficult following the announcement by the company in the Q3- 2020 8-K filing,

Since the beginning of the pandemic, we and others in our industry have addressed the growing customer demand for PPE products by increasing and improving the human, mechanical and supply chain components behind production. Even with these increases and improvements, customer demand for PPE products, face masks in particular, continues to exceed industry supply in many instances, and we believe that this may continue for some time. Due to this customer demand and the current state of the industry, we expect continued face mask sales growth during the fourth quarter and into 2021, but much of our production will be presold. Industry-wide reports also appear to indicate that, even with the significant increase in supply, demand will continue to outpace capacity for immediate utilization, with longer-term stockpiling not realistic until late 2021 and into 2022. As a result of these developments, and in the interest of protecting the Company’s competitive position, we will no longer provide intra-quarter updates on order levels and backlogs.

The foregoing suggests demand for face masks will exceed supply through 2021 and into 2022. That makes it a little easier to project APT's 2021 and early 2022 face mask sales on the basis of projected maximum production capacity. Let's say mask sales continue at full production capacity through mid 2022, by which time widespread COVID-19 vaccination should be achieved, and a stockpile of masks for possible future pandemics established. What is likely to happen then is sales of face masks will "fall off a cliff" due to massive excess production capacity, similar to what has already happened with face shields. And there likely will be massive excess production capacity because producers, other than Alpha Pro Tech, are also ramping up production capacity. Per this 25 March 2020 Bloomberg article,

The company (3M) has in two months doubled global production of N95 masks to about 100 million a month, and it’s planning to invest in new equipment to push annual mask production to 2 billion within 12 months.

and

Honeywell is also increasing N95 production, saying it will hire at least 500 people to expand capacity at a facility in Rhode Island.

I expect even for those willing to wear a face mask, that willingness will lessen over time, due to the inconvenience and as the necessity reduces as widespread vaccination is achieved.

Based on the above, I have compiled Table 2 below, projecting disposable protective apparel sales out to 2024.

Table 2

I have run the above assumptions through my financial models for APT and come up with projected net income results per Table 3 below.

Table 3 APT Historical and Projected Income Statements

Table 3 shows historical and projected net income for APT based on achieving incremental sales of disposable protective apparel per assumptions in Table 2. In addition to the incremental sales, it is assumed the underlying protective apparel business revenues grow at 0.5% per year, which is around average growth levels over the past several years. I believe the standout statistic in this table is the building supplies growth for 2020 over 2019, both in revenue and in net operating income. I have made an arbitrary revenue growth rate assumption of 5% per year for 2021 to 2024. This is well below the growth rate for 2020 versus 2019. From the Q3-2020 8-K earnings release,

Building Supply segment sales for the nine months ended September 30, 2020 increased by $2.3 million, or 11.0%, to $22.7 million, compared to $20.4 million for the same period of 2019. The Building Supply segment increase was primarily due to an increase in sales of housewrap of 11.2%, an increase in sales of synthetic roof underlayment of 9.4% and an increase in sales of other woven material of 19.6% compared to the same period of 2019. Synthetic roof underlayment sales increased as a result of increased sales of the Company’s TECHNO family of products. Synthetic roof underlayment and housewrap sales were positively affected by improved U.S. housing starts. Other woven material sales were up as a result of our largest customer in this category increasing its order volume. The sales mix of the Building Supply segment for the nine months ended September 30, 2020 was 46% for synthetic roof underlayment, 45% for housewrap and 9% for other woven material. This compared to 47% for synthetic roof underlayment, 45% for housewrap and 8% for other woven material for the nine months ended September 30, 2019.

Post COVID-19 pandemic, the protective apparel business may come under pressure as a result of excess production capacity built up by APT and others. It is comforting the other building segment of the business is growing strongly. APT has no shortage of cash to invest in further growth of the building segment.

My financial models for APT include projected balance sheet, and of course, 'equity bucket'. Rather than provide all that detail it is simpler to display relevant data from these models in my 1View∞Scenarios™ dashboard. Before doing that, I should explain a little about the Dividend Growth Income+ Club approach to financial analysis of stocks.

Understanding The Dividend Growth Income+ Club Approach

Total Return, Dividends, Share Price

The only way an investor can achieve a positive return on an investment in shares is through receipt of dividends and/or an increase in the share price above the buy price. It follows what really matters in share value assessment is the expected price at which a buyer will be able to exit shares, and expected cash flow from dividends.

Changes in Share Price

Changes in share price are driven by increases or decreases in EPS and changes in P/E ratio. Changes in P/E ratio are driven by investor sentiment toward the stock. Investor sentiment can be influenced by many factors, not necessarily stock-specific.

"Equity Bucket"

Earnings are tipped into the "Equity Bucket" for the benefit of shareholders. It's prudent to check whether distributions out of and other reductions in the "Equity Bucket" balance are benefiting shareholders.

Table 4 APT Modeling To Achieve A Target Rate Of Return Utilizing The 1View∞Scenarios™ Dashboard

As the name of the dashboard implies, it allows infinite scenarios to be explored by changing the assumptions in the blue shaded cells. APT does not pay a dividend, so the only way to achieve a positive return is by buying shares at a price that allows to sell at a higher price in the future. From the discussion further above, it should be apparent there is considerable uncertainty in relation to the level of sales of APT protective apparel over the next few years. Table 4, as displayed, reflects the same assumptions included in the actual and projected net income statements per Table 3 above. Changes to assumptions flow into the net income and balance sheet models and relevant outputs are displayed in the outcomes section in Table 4. Table 4 goes beyond the financial models and includes projected rates of return. With the degree of uncertainty in relation to the volume and duration of COVID-19 related sales, I would have preferred to target a 10% average yearly return for holding through end of 2024. At current share buy price, I believe that would be difficult to achieve. Instead, I have assumed a buy price at the current share price of $12.10 at close on Dec. 11, 2020 and a share price of $16.38 at end of 2024. This provides a 7% return for holding through end of 2024, based on the assumptions per Table 4. By 2024 it is assumed incremental pandemic related sales will have ceased, and EPS will have returned to routine levels. Because of the large cash balances expected to be generated, P/E ratios will be distorted by the impact on share price. In effect the share price is likely to be composed of two elements - EPS multiplied by routine P/E ratio, plus an element representing cash on hand per share. In order to arrive at the $16.38 share price at end of 2024 which returns 7% average per year, the P/E ratio required to be applied to 2024 EPS is 35.0. This is rationalized further down in the dashboard by applying a P/E ratio of 14.6 (similar to average of FY 2018 and FY 2019 historical P/E ratios) to 2024 EPS to arrive at a $6.85 per share value of the underlying business. To this is added the projected $9.54 cash per share to arrive at the estimated $16.38 share price at end of 2024. Note that I have run the model, under similar assumptions to Table 4, to return 10% per year through end of 2024, and this would require a buy price ~12.5% below current share price.

Share repurchases -

Table 4 has provision for input of share repurchases, which could be used to deploy idle cash. In fact, APT have signaled share repurchases per Q3-2020 10-Q,

Pursuant to the Company’s share repurchase program, on September 22, 2020, the Company announced that the Board of Directors had authorized a $5,000,000 expansion of the Company’s existing share repurchase program. All of the shares included in this table were purchased pursuant to this program.

It is my view APT have always acted cautiously and prudently in relation to share repurchases at times of elevated share prices in the past, such as during the SARS outbreak. Purchases in September 2020 were 20,000 shares at an average ~$14.00. These were the first since 35,100 shares were repurchased in Q1-2020 at an average ~$3.56 per share. It will be interesting to see what if any shares are repurchased in Q4-2020.

Table 5 below shows the potential impact of substantial share repurchases on outcomes, compared to Table 4 above.

Table 5 APT Modeling To Show Potential Impact Of Share Repurchases Utilizing The 1View∞Scenarios™ Dashboard

In Table 5, I have allowed for additional share repurchases of 3 million in 2021 and 1 million in 2022. This reduces cash balance, but significantly improves the EPS per share at end of 2024. Under the revised assumptions, I am able to increase target return to 10% for holding through end of 2024, and still be able to justify ending share price based on cash and underlying business components.

APT: Conclusions

APT is close to or coming into suitable share price buy range, but this assessment assumes, and relies on, projected high volumes of pandemic related sales through end of 2022. There is also an assumption of 5% per year growth for the building segment through end of 2024, which requires testing. I regard the management as smart operators and if the company commences large scale share repurchases that should be of comfort the shares are at an economic buy price.

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This article was written by

Robert Honeywill profile picture
7.91K Followers
I am a retired accountant with a background in large mining projects, from feasibility to full-scale operation, large scale primary industry and food processing, commercialisation of university intellectual property, and consulting to small businesses, government departments and insolvency practitioners. I have gained a wealth of experience from having the extreme good fortune to work, in a cooperative environment, with so many people far more intelligent and smarter than me; from scientists and engineers with MBA qualifications, to University professors across a range of disciplines. Through the accident of mergers, acquisitions and dispositions, I held, at various times, financial controller positions within Utah International Inc, General Electric Inc, and BHP Billiton organizations. If I have a special skill, it is in methods of assessment of projects with long lives, where costs are front loaded and/or future revenues are subject to considerable degrees of uncertainty. In relation to stocks, I have a theory, using projections to calculate a present value per share is far less useful for a share buying decision, than using those same projections for calculating future value per share for determining potential exit value and rate of return.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such investments for their specific situation. Neither information nor any opinion expressed in this article constitutes a solicitation, an offer, or a recommendation to buy, sell, or dispose of any investment, or to provide any investment advice or service. An opinion in this article can change at any time without notice.

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