Alpha Pro Tech Limited: Update From February 9, 2021

Summary

• One month is too short a time to judge how well this investment has performed - it is off to a rocky start and has been quite unsettling.
• The short-term stress that the stock price is going through appears to be based on the idea that many states are lifting the mask mandate.
• I do not trust stock price movements, I trust fundamentals.
• Looking for a helping hand in the market? Members of The Dividend Kings get exclusive ideas and guidance to navigate any climate. Learn More »

Introduction

On February 9, 2021 I produced the article titled “Alpha Pro Tech Well-Positioned To Participate In COVID-Led Growth.” In that original article I pointed out that Alpha Pro Tech (NYSE:APT)was well-positioned to participate via earnings growth because of selling masks and other protective gear relevant to the COVID pandemic. I also provided earnings estimates courtesy of FactSet and corroborated by Reuters on Yahoo Finance and by Standard & Poor’s courtesy of Seeking Alpha. To date, those earnings estimates have not changed. Unfortunately, the same cannot be said about the stock price.

Anyone who has followed my work for a long time knows that I trust earnings (fundamentals) more than I do price volatility. Nevertheless, although not alone in that position, I believe we are certainly in the minority. The stock has dropped from $16.49 per share when I wrote the article, and as I write this is down to $11.41 for an additional 8.24% drop today. Which means the stock has essentially fallen about 30% since I wrote the original article.

Now, a 50% plus drop is certainly concerning, it becomes less concerning when you consider the fundamentals in the valuation that they represent. Additionally, when you consider the short time period that this has happened over, this is hardly a long-term mistake. It may turn out to be, and time will tell. However, I am not a day trader and I do not forecast short-term stock price movements, and as I have written many times, I do not trust stock price movements, I trust fundamentals. The fundamentals of this company have not deteriorated, in fact, they have gotten slightly better than they were when I first wrote the article. The fact that people are currently selling the stock means nothing if in the long-term scheme of things, the earnings come in as expected over the next two years.

In other words, the long-term upside to this investment remains the same. If that turns out to be true, then the smart thing would be to double down on this investment once the bleeding stops. I am confident that is going to happen because this was a solid business prior to COVID, and will likely be a solid business post COVID. On the other hand, I am not confident that this business will keep growing at these recent extraordinary rates once COVID is over. Nevertheless, I also shared excerpts from a Wall Street Journal article that suggested that “Covid 19 will be around for years – and a big business.” Here is the excerpt from that article that I shared:

“But some organizations are planning for a long-term future in which prevention methods such as masking, good ventilation and testing continue in some form. Meanwhile, a new and potentially lucrative Covid-19 industry is emerging quickly, as businesses invest in goods and services such as air-quality monitoring, filters, diagnostic kits and new treatments.”

The reason I bring this up is because the short-term stress that the stock price is going through appears to be based on the idea that many states are lifting the mask mandate. However, even where the mandate has been lifted, people were still wearing masks. Moreover, I believe people will continue wearing masks for some time into the future regardless of whether it is mandatory or not.

What is really interesting is that Alpha Pro Tech is tentatively scheduled to report earnings on March 9. I believe that will be an important happening to the fate of this company. I would expect they will come close to meeting current estimates of $1.79 a share for fiscal 2020. The real question will be if guidance and/or estimates for 2021 - which currently sit at $2.49 - materially change or not.

Alpha Pro Tech February 5, 2021

Here is what Alpha Pro Tech looked like when I published the article on February 5. Note the surge in earnings growth but further note the extreme volatility that the stock had gone through in the last two years. That obviously has not changed or subsided, at least yet.

(Source FAST Graphs)

Alpha Pro Tech: Here Is What It Looks Like Today

Even though the price drop has been severe and considering that it is down another 8% or so today, when you look at it on the below graphic and measure it relative to earnings expectations, your perspective might change. The magnitude of the drop as previously stated has been 50%, but relative to the expected earnings growth the stock still looks extremely undervalued. Most importantly, although they might, expectations for earnings for this year and next have not yet changed.

Summary and conclusions

One month is too short a time to judge how well this investment has performed. Admittedly, it is off to a rocky start and has been quite unsettling. This company was suggested to me and after reviewing it and researching it I offered it as a compelling speculation and play on the COVID-19 pandemic. The thesis still seems to be intact and only the valuation has changed thus far. However, the fundamentals could change dramatically. Therefore, I believe it is currently prudent to wait a few days until the earnings report comes out before a final decision should be made. Even then if it looks positive, this should be looked at as an interesting speculation. Caveat emptor.

Analyst’s 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. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[livingonthebeach]

Gotta be the worst call Chuck has ever made!

[Strategic Investor]

@livingonthebeach Yeah, but it got clicks & comments, didn't it?

[BM Cashflow Detective]

@livingonthebeach

Yes, the timing wasn't that good.

There was already too much Covid optimism priced into this company because one generally buy companies before a crucial event has occurred and not after.

Nobody is perfect and is always right, that happens.

But the story of $APT is not over yet.

The analyst consensus expects the company to continue growing at a long-term rate of 15% CAGR.

Alpha Pro Tech Ltd is excellent value based on its 5y PEG ratio of 0.32%.

After that, the company would be a strong buy.

the past is the truth

the present is a coincidence

and the future is a theory.

[crackshot123]

Anyone curious to see the JV breakdown of numbers? They make one entry on the balance sheet each quarter with NO detail. APT either put up all the money or guaranteed their partner's loans, and got a whopping 42% of the partnership. Really? And now they are investing another $4 million + in that market (housewrap etc)....And, I understand almost 100% of the total revenues of the JV is due to orders from APT. So, APT get's 42% of the profits of JV but is 100% of the business? Something fishy here it would seem.

[4Logos]

@crackshot123 disclosures, reserve management, goodwill impairment, revenue recognition...I could keep going

I am not saying any apply to this name, but small caps without a big auditor are a recipe for accounting and reporting issues

as you have pointed out!

[Strategic Investor]

@crackshot123 Your characterization of the reporting is a bit unfair. There is both a balance sheet and an income statement entry as they use equity method accounting for the JV. This is maybe less information than you want, but nothing unusual for this sort of operation.

Moreover, there is an entire footnote about the JV which details somewhat the setup of the thing. Basically, they guaranteed a bunch of orders and effectively seller-financed much of the working capital needed to start the operation. In return, APT got its money repaid AND retained a residual ownership of 42% of the equity. The local operators, however, who do the work of running the thing retain a narrow majority. This doesn't seem that bad a deal for APT? I mean, yes, many firms would have chosen to set up a 100% owned offshore operation but APT was a tiny company when they did this and the small team in global headquarters probably lacked (and probably still lack) the means to properly oversee that operation, as it would have likely meant having someone from the parent more or less permanently stationed at the JV. Larger firms can do this, and cycle people through as part of their maturation, but APT would likely have found it hard to supervise. Many similarly situated firms would simply resort to a supply arrangement, which leaves you more vulnerable to supply interruption.

So instead they found a partner they liked and found an operating arrangement similar to an offshoring (with the ability to coordinate closely and to review the books and participate in business development discussions, capital allocation and such) but without the need to directly oversee the operation. There was perhaps also a hope / expectation that the JV would develop other customers to reduce dependence on APT. That does not seem to have happened.

I do think that the JV seems to be building up rather alot of equity and it seems to be retaining more earnings that are necessary to support the level of sales of the business. When I was a shareholder, I was looking for a sizeable (seven figure) distribution from the JV. I have not seen it, so far.

Anyway, I don't think that the auditor is somehow being slipshod. Managements create these sorts of JVs all the time and intentionally ensure that the company has less than 50% ownership so that they do not have to consolidate the subsidiary. The amount of disclosure required is simply not that high.

And - in fact - if you compare the JV to the rest of the company, the level of aggregate risk there is not that high from a balance sheet or an income statement perspective. Prior to the pandemic there were years in which the income from the JV was comparable to the operating income of the business, but after the old CEO "was departed" and the new team came in and started cleaning up the balance sheet, the importance of the JV has been modest compared to the rest of the company. As recently at 2019, the JV represented 1/12th of income before taxes; 8% is not nothing, but it's hardly existential. Because of the build in retained earnings, they had come to represent more than 10% of the assets, but again, not world ending.

Since the pandemic the JV is a trivial part of the whole. The pandemic sales are likely to be transitory, so the import might rise again in the future, but likely to pre-pandemic income statement effects.

We might want to know more about the JV strategy and such, and if so, I suggest you call management and ask them.

[crackshot123]

@Strategic Investor Moreover, there is an entire footnote about the JV which details SOMEWHAT the setup of the thing.--- In fact, the first "JV agreement" filed with the SEC showed a 50/50 split, then somehow it changed to 42/58.....why? Equity method accounting is based on "control". APT could say they have none. Yet, they have half the board of directors and represent 100% of business of JV -- control in my book. You make some good points, but the percentages you refer to are significant in my opinion. And, now they are investing (according to the scant PR) about $4.5 million new capital in JV. My biggest problem is running a company like it is private with little communication to shareholders and no following from analyst. Oh, except for the release last year on 2/27 disclosing HUGE orders due to the pandemic when the stock was around $8 and then selling most of the insider shares the NEXT day at $38. Please tell me I am wrong about this last point?

[YellowLab1]

@dolson @Lost in America APT blasting higher now up nearly 9% today. I’ll take it and hold. Small cap undervalued Industrials may be in the sweet spot

[4Logos]

@YellowLab1 I read the BM Cashflow Detective post and decided to look up their auditor...Having worked the better part of my career in the Big 4, I can tell you I would not trust a local accounting firm with my money...I am out tomorrow

Chuck - if you are reading this, I love you...but you really need to add a new screen on who the auditor is for a small cap before recommending the stock...to much risk in playing with the numbers with these guys, without a big nuts firm to keep them in check, this is a recipe for disaster, IMHO!

[crackshot123]

@Lost in America You are the perfect person for me to ask this question (sorry to bother). I sold half my position. Have you looked closely at APT books? The JV in India (Harmony Plastics is APT portion) really bothers me. First, it's not consolidated for earnings/income and we see NO detail. Yet, APT has half the board seats AND accounts for 99% of the revenue of the JV (maple industries). This goes deeper. Also, how can a public co do a PR pumping their stock on the 1/27/20 THEN sell A Lot of their insider shares on 1/28/20? If all this makes it past the audit team, not to mention legal counsel, I'm just stupid....which might be the case. Any thoughts?

[4Logos]

@crackshot123 I tend to trust the analysts I follow and only beat the financials up when I think others have not...in this case I trusted Chuck, but when I discovered that they had an off brand auditor as their accounting firm, I went no further

not worth the time as I will exit soon on an uptick

One big risk factor for me that I think many do not understand, as you and I do, is the games that mgt can play and also that the smaller caps can get away with shady deals/promotion

I have seen too much accounting abuse in my lifetime, and the smaller audit firms bend over backwards to keep clients

Read the post below by Cash Flow Detective for more potential irregularities

[Michael Bryant]

"Which means the stock has essentially fallen about 30% since I wrote the original article.

Now, a 50% plus drop is certainly concerning, it becomes less concerning when you consider the fundamentals in the valuation that they represent."

30-50% in a great range for a contrarian buying opportunity, especially since Elliot Wave Theory gives 38.2% as an important Fibonacci Retracement and 50% is also a common fibonacci level. Technically, $APT was oversold based on the RSI at $10/share on Wednesday and very oversold based on the W%R. And I totally agree with you that the fundamentals look like the stock in very cheap. A PE of 7 and forward PE of 4 is very inexpensive.

Great article.

[Strategic Investor]

@Michael Bryant Those P/Es are not annuities. You can't price them like one. They are peak cycle P/Es.

You have to break this business into two (or three) pieces.

- A "normalized" firm run rate where you estimate the long term prospects of the operations.
- A "COVID windfall" of a certain magnitude and duration and value that
- Cash and the optionality of reinvestment or distribution.

It's a special situation, not a typical stock. But go on with your Elliott Wave.

[FRM73]

@Michael Bryant bought 1000 @$10.18

[Michael Bryant]

@FRM73

Great buy. I bought a bunch at $10.08 on Wednesday and sold about 60% today at $10.49. Saving the rest for when $APT goes higher. If you buy a bunch, then you only need 3.5% gain to make a decent (but not huge) profit. Not bad for two days!

[Strategic Investor]

Recall that before COVID this was a small company that was generating cash and repurchasing stock (ultimately rewarding insiders) that was worth about $4, which is pretty near to where it traded.

Then COVID, mask mandates and MOMOs and $41.

Thing is, nothing else in its end markets is much changed, the competitive position of APT housewrap and roof underlayment and such is unchanged from where it was. It's possible that housing could have a boomlet on the other side of COVID, but the fundamentals aren't going to be that different medium term: family sizes are getting smaller and will stay that way as long as we believe in men and women pursuing degrees and advanced degrees. Housing is like to continue to urbanize, etc.

So, basically the way to value this is: take the normalized pre-COVID value and apply an adjustment for the windfall profits of the COVID period. Both of these are necessarily imprecise values. Included in the windfall profits, for instance, has to be an estimate of the option value of the significant cash reserves of the company - could that be converted into something even more valuable via an acquisition or such.

Anyway, I think a company that was worth say, $40m-$50m pre covid, and which will earn $30-$40m in excess profits from covid (or more if you believe we will have a return to late 2020 conditions as a result of some new outbreak) is still far below the present market value.

That is true even if you price in a probability of another pandemic within the next 2-3 years, though admittedly, such a factor could close the gap; but what are the odds (they are non-zero and depending on how much culpablity you assign to the Wuhan virology lab, might happen within a normal discounting window).

[crackshot123]

Couple questions for author and others in the know: 1) do you think it is appropriate to not consolidate the India JV? And, since its portion (42%) of JV earnings is added to the balance sheet investment, does that understate income and/or the value of ownership of that JV? 2) Has there ever been discussion of stock sales back in Feb 2020 where a PR was issued with positive outlook and insiders sold much of their stock/options within 24 hours (it appears)? 3) They have no debt, thus no investment bank relationship, thus no street research. Should they hire a firm to study strategic alternatives? thank you!

[desertman]

Chuck - APT closed at $10.70 today 3/9. Do you still stand by the recommendation based on fundamentals? Down over 40% in last several weeks.

[Flex68]

@desertman ,

Chuck pretty clearly illustrated his stance.

Fundamentals remain sound, and analyst recommendations remain Bullish, for what those may be worth, though Mr. Market can remain illogical longer than many individual investors can remain solvent.

Have you done your own research and dd ?

Tech analysis and momentum stink, and APT has fallen through support.

However, the fundamentals rock.......

As a speculative investment, though, I was happy to get in at around $11.

The past couple of days have been bad, but that is what a Stop Loss is for

[djrryan]

Chuck, by all business metrics this does seem like a good company. I ended up buying some Monday ... but wish I bought today :-(

[YellowLab1]

@Chuck Carnevale and others. Earnings out. "Record net income in 2020 of $27.1 million, or $1.94 per diluted share, compared to net income of $3.0 million, or $0.23 per diluted share, in 2019". Seemed to beat top and bottom line. And forecasting for 2021 with increasing sales of all product lines except masks, which naturally “normalizing” as mandates lifted. Sell off seems related to 2021 guidance not specified as compared to say a $2.49 estimate. So undervalued and in reflation trade industrials small value so may be very attractive.
Thoughts ?

[pat45]

earnings are good .53 v 50 exp stock is down but I bought more. APT needs an analyst rec like LAKE and OMI got both those holding and in same field but are 4x expensive.

[FRM73]

@pat45 why is it down 15% then? I don't get it.

[pat45]

APT earnings should be this week and should be fantastic. Other PPE sell at PE of 20x where APT has PE of 5. APT, OMI and LAKE

[Wimal]

APT President and CEO, Lloyd Hoffman's comments on Nov/5/2020
are a clue of what to expect in the next earnings report;

“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.”

www.alphaprotech.com/...

[Wimal]

@Chuck Carnevale "The real question will be if guidance and/or estimates for 2021 - which currently sit at $2.49 - materially change or not"

> Your entire bull case for APT dependent on this *single* estimate by

analyst Howard Halpern at Taglich Brothers;
taglichbrothers.com/...

Given your many years of experience with analysts' estimates, is that prudent?

[Pistolero Yogi]

@emthree this is not supposed to be "prudent" this is for speculation.

[PPinvest]

Thank you for the good follow up. Some are done with the pandemic. So masks for the medical community are no longer be needed? Does everyone know that $APT is a approved PPE provider, for the medical community? $APT was cheap at 16$. Upside potential at 12$ and short quote at > 20% is great.

[Flying Dutchman 2]

Chuck, you are such a huge part of my investing success over the past three years, that even if this one particular trade doesn't work out, (yet to be determined), it really doesn't matter in the big picture. You are the best and most accurate author on this website, and I appreciate you.

[nkalakatta]

Thank you for the update... i continue to buy the dip. Every country also needs to make their reserve. Masks shortage cannot be an excuse anymore.

[livingonthebeach]

Chuck, C’mon man! I put my entire life savings in this stock. Yeah No. I did get a few shares based on your first article but no risk no reward.

[dummystuff]

There’s only one analyst with coverage that I’m aware of, but they just basically cut and paste from the corporate financials without providing any meaningful commentary.

One item that interests me was their huge increase in sales to Australia in the 9/2020 quarter; if I recall, it was over $6 million for the quarter, versus well under a million for the prior full year. Was only mentioned in the footnotes; not discussed at all in the quarterly letter. Something significant could be going on there.

How do you know the earnings release date is March 9?

[Flex68]

@dummystuff ,

Taglich Brothers

"...but they just basically cut and paste from the corporate financials without providing any meaningful commentary."

Not sure that I found their offering to be even that comprehensive, lol

[BM Cashflow Detective]

I have not yet invested in Alpha Pro Tech as I prefer heavily oversold situations. But that has now happened.

But there are also some data that call for great caution. Almost all future assumptions are based on the analysis of a single analyst. The company's fundamentals look solid, at least with some reservations.

But.

The Beneish M-Score -2.15 no higher than -1.78, which means that the company is "likely" not a manipulator. The gap is not great, but not entirely convincing either. At -2.15, it's still a possible manipulator. The fluctuations in previous years were also enormous. For the past 13 years, Alpha Pro Tech's highest Beneish M-Score was 1.45. The lowest value was -3.67. And the median was -2.37. In fact, Alpha Pro Tech was at times a theoretical manipulator of its own balance sheet with 1.45 according to the Beneish M-Score.

There are currently some references to earnings quality, accounting quality and the management of reserves that underpin a cautious investment approach.

Accruals are estimates by company management of non-cash expenses, assets and liabilities that are recognized before they are paid. They are calculated as net operating cash flow less net income.

The analysis of accruals can help signal possible earnings management of reported net income and EPS results. For example, 'Over-Accrued' can signal under reported net income and / or the building of balance sheet reserve accounts, while 'Under-Accrued' can signal inflated Net Income results and / or release of balance sheet reserves to aid reported earnings.

Recent trend for Alpha Pro Tech's accruals.

The annual trend suggests that Alpha Pro Tech's accruals to revenue ratio has increased 3.70 percentage points from last year's low but is still below its four-year average accruals to revenue ratio of 4.64%.

While its accruals to revenue ratio increased to 0.22% from -3.49% (in 2018), its peer median decreased during this period to 8.47% from 9.18%.
Relative to peers, accruals to revenue ratio rose 4.41 percentage points. On a quarterly basis, Alpha Pro Tech's accruals to revenue ratio is its lowest over the last five quarters and compares to a high of 22.03% in March 31, 2020. The decrease in its accruals to revenue ratio to -26.04% from 4.66% was also accompanied by a decrease in its peer median during this period to 1.41% from 9.77%. Relative to peers, accruals to revenue ratio fell 22.34 percentage points.

The financials suggest possible aggressive accounting with overstatement of net income.

Alpha Pro Tech has reported relatively strong net income margin for the last twelve months (23.64% vs. peer median of 0.89%). This margin performance combined with relatively low accruals (-1.14% vs. peer median of 1.29%) suggests possible aggressive accounting and an overstatement of its reported net income.

Alpha Pro Tech's accounting suggests some amount of draining in its reserves.

Alpha Pro Tech's accruals over the last twelve months are around zero. However, this modestly negative level is also less than the peer median which suggests some amount of draining of reserves.

For clarification it must be said that these are only "indications" for the own caution and appropriate assessment. Alpha Pro Tech can be a balance sheet manipulator, but it doesn't have to be.

Since the last scandals of the German Wirecard and the British Patisserie Holdings PLC it has been made clear again that even supposedly debt-free companies can fall victim to bankruptcy or fraud. Another currently possible case of inconsistencies is Ebix.

I don't have a final opinion on $APT myself. But I see it as an investment, with strong fundamentals and a high speculative character. On the other hand, a small speculative capital allocation could enable profits with multiplying potential.

If it's too good to be true, often it's not true.

But if it's true, it could also be far more than good.

[dummystuff]

@BM Cashflow Detective

“The financials suggest possible aggressive accounting with overstatement of net income”

The answer is simple - revenue accruals increased due to a spike in Covid related orders. To imply that it is deceptive accounting is ridiculous.

[BM Cashflow Detective]

@dummystuff
"revenue accruals increased due to a spike in Covid related orders"

Not right. You did not read the comment correctly and instead reinterpreted it.

The accruals to revenue ratio increased to 0.22% in "2019". The year before Covid 19.

But in the "last 12 months" a relatively low accruals -1.14%, despite the reported relatively strong net income margin also because of Covid 19.

That is the exact opposite of what you said.

Overall, the lower accruals "could" indicate issues. For example, the AR growth is higher than Revenue growth and the AP growth is lower than Revenue growth. AP Days level is lower compared to the peer average (DSO). Cap-Ex growth is higher than revenue growth. Cap-Ex to depreciation ratio is higher compared to the peer average. Cap-Ex to depreciation ratio is higher compared to the prior period. Cap-Ex to Operating Cash Flow ratio is higher compared to the peer average. Cap-Ex to Operating Cash Flow ratio is higher compared to the prior period. SG&A growth is lower than revenue growth. R&D Days level is lower compared to the peer average (DSO). SG&A Days are growing at a lower rate than the peer average. Difference in Accounting and Cash Taxes is higher compared to the previous period. Difference in Tax Provision and Cash Tax Rates is higher compared to the previous period.

It doesn't have to mean anything, but it can. Besides, I didn't imply anything, just considered it. This is something completely different.

Careful due diligence takes all circumstances into account as far as possible. Especially with a small caps company like $APT that is only observed by an analyst.

My analysis means nothing more and nothing less. After that the answer is not that simple and certainly not ridiculous. That is what Wirecard shareholders thought before bankruptcy too.

"Risk comes from not knowing what you're doing".
- Warren Buffett

[dummystuff]

@BM Cashflow Detective you are correct; I misread it. My mistake.

[blue blue sky]

IBD who I think is very credible has this listed as a top growth and earnings stock too. I agree with you Chuck.