- Covid-19 resulted in massive cash reserves and a high return on assets.
- This cash can easily be utilized to grow its adjacent building supply segment that has already seen growth in 2020.
- Growth in housing construction will help APT effectively compete in competitive markets.
Recently I had the pleasure of reading The Little Book That Beats The Market by Joel Greenblatt. I was introduced to the magic formula and while the underlying mechanics are fairly complicated, on the surface it's rather simple. It looks at return on assets and earnings or PE ratio as a way of analyzing compounding rates in relation to stock price.
Alpha Pro Tech (NYSE:APT) was one of these stocks that popped up on the magic formula screen. After taking a look at its fundamentals compared to its price, I have to admit, it was sort of refreshing to look at. I mostly look at stocks trading below book value, but this stock was far more interesting.
Thesis: APT trades at a low P/E of ~5 and its return on assets over the past 12 months exceeds 50%. This makes it extremely undervalued and a compounding machine. Its massive cash reserves will make it easy to capitalize on the growing building supply segment.
There is no doubt that Covid-19 has been a major windfall for the PPE segment of Alpha Pro Tech, but I believe the building supply segment is underappreciated and overlooked.
A Growing Building Supply Segment
Disposable protective apparel is not just for hospitals, it's also utilized in construction. Painters are just one example who use N95 face masks on a regular basis.
So for those who fear APT will lose all of its PPE revenue, just know it's highly unlikely as I will outline below.
The building supply segment not including PPE consists of:
- Synthetic roof underlayment
- Housewrap accessories: flashing and tape
- Other woven material
These are weatherization products and are becoming increasingly important in the near future as eco products that reduce energy usage. With the growing intensity of many storms in the United States, these building supplies are also an important weather-resistant barrier.
Below is a breakdown of the building supply segment compared to PPE. It compared 2020 and 2019 numbers.
Looking at the 2019 numbers, we can get a better idea of how the two segments typically compare to each other. It's essentially a 50-50 split between the two with the building supply actually commanding a higher share of sales.
This bodes well for APT and its future as a compounding machine. If we take out 2020's outstanding numbers and just compare its return on assets on a normal year of growth it still sits around 20-25% ROA. We can even see that in its five-year return on assets.
Let's not forget that building supplies are growing under the shadow of 2020's PPE sales. The massive amount of cash on hand that APT now has will further fuel the growth machine.
Even if you buy at today's levels of a little over 9 dollars, in 4-5 years it will be as if you had bought below book value because the company and its underlying book value will have essentially doubled.
Indian Distribution and Manufacturing
Most of APT's disposables manufacturing takes place in India with some being produced in Asia and Mexico. This I see as a positive since China is not being utilized and it does not leave APT exposed to tariffs or geopolitical tensions between the United States and China.
As I outlined above, the building materials supply segment is experiencing a lot of growth, and as such, APT has entered into a joint venture with Maple Industries in India. This joint venture is known as Harmony Plastics and APT owns 41.66% of its operations.
APT has also committed $4 Million to increase production of its building supply segment. This commitment to expanding its building supply segment is very encouraging for when PPE demand falls off as we exit the Covid-19 Crisis.
Share Repurchases Destroy Value
APT authorized a share repurchase program of $42.52 Million of common stock. As of December 31st, they only had about $4.48 Million left to repurchase.
I would normally say this indicates management thinks the shares are undervalued and don't know what to do with the cash they have on hand, but I'm not a big advocate of purchasing at double book value.
Having said that they are compounding at a very high rate, so it may make sense to buy back some shares now since they will be worth more in the future before they can put all the cash to good use.
Management also states that they favor buybacks over a dividend which I believe is backward thinking. The cash belongs to the shareholders in the form of a dividend rather than buybacks because it is more efficient for the market to judge the worth of the company.
If you are a bit curious at the prices that APT bought back shares at check out the below and take solace in the fact that you are buying below those levels.
Competitive Industry and International Expansion Potential
APT competes in a very competitive industry where giants like 3M exist. This makes it very difficult to compete and could erode margins. Luckily APT has a very robust supply chain and is currently competing effectively.
The growth in construction for the next few years will also allow for plenty of players to compete effectively. Although APT never exclusively mentions its products are for residential homes all of its housewrap photos signal that it is in the residential market.
APT has a lot of room for international growth since most of its sales are in the United States. Over the next year, we could see some international sales pick up and APT could announce a push for more international sales.
Risk Reward Prospects of APT
It's difficult to invest in expensive markets. Not to mention the United States market has been notoriously difficult to find bargains. That's why I rather enjoy looking at companies using the magic formula.
While digging into APT the risk-reward is rather reasonable. Its current price is about double its book value and it has cash to cover any and all debts. If APT drops 50% in value you will essentially be holding a profitable company with a ton of cash and all you have to do is wait a few years for the value of the company to double. That sounds like a good trade-off to me and if it does drop in value, why not buy more?
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Analyst’s Disclosure: I am/we are long APT. 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.
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