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Alpha Pro Tech LTD (APT) is a Canadian micro-cap company offering products in three different operating segments: Protective Apparel, Building Supply, and Infection Control.

The stock is down almost 70% from a high of over $7 back in October 2009. APT saw significant increase in sales due to the outbreak and threat of the H1N1 flu virus, as it increased demand substantially for the company’s protective gear.

In 2010, comparable numbers are off significantly as the H1N1 threat has abated – the market has punished the stock despite a solid balance sheet and continuing profitability.

This is a great example of the market overreacting, providing an opportunity for savvy investors to pick up shares on the cheap.

Segment Breakdown

Alpha Pro Tech (APT) - Sales Breakdown

The company sells a variety of disposable protective items including shoecovers, caps, gowns, masks and eye shields, along with house wrap and synthetic roof underlayerments on the building materials side.

2009 was an incredible year for the company, with sales increasing 66.8% compared to 2008, driven by strong results in the Infection Control group. Infection Control sales almost tripled, as customers stocked up on protective gear to combat the H1N1 flu strain.

Despite the sharp drop in protective gear sales from the 2009 high-water mark, the company has managed to hold revenue numbers fairly steady in 2010, primarily due to growth in the Building Supply segment.

Building Supplies now make up over 41% of total revenues, almost double the segment average over the past five years.

Financial Information

Revenue has grown at 12.7% per year over the past five years on a solid gross margin of 46.4%. Both operating and net margins have remained stable as well, at 12.1% and 7.6% respectively.

Margins will fall as the company increases its focus on the lower margin Building Supply business, but the growth prospects should help to make up the difference.

5-yr CROIC (11.9%) and ROE (12.3%) are respectable although not outstanding.

On the balance sheet side, book value has increased at a steady rate of 16.6% per year and currently sits at $1.56/shr.

Last quarter, APT made significant inventory purchases across all product lines in order to strengthen marketplace position and ready for future sales. The company expects to generate and stockpile cash in the second half of the year as it works through inventory.

Loss of Key Distributor

In 2009, 28.7% of company sales were to VWR International, the company’s largest distributor. However, on March 29 2010, VWR decided to stop carrying Alpha Pro Tech’s product line and launch its own competitive line of products.

Although the company has slowly been transitioning away from VWR (the distributor made up 45.7% of sales in 2007), this will still have an adverse effect on financial performance as the company moves to a broader distributor network.

So far in 2010, Protective Apparel sales are off 26% – although the other business segments have picked up the slack, it remains to be seen whether the company will be able to stabilize sales through a broader distribution network.

Catalysts

Share Buybacks

In April 2009, the company announced a $2m stock repurchase program. The plan was expanded to another $2m in February 2010. While repurchases have slowed in 2010, the company has managed to retire over 6.1M in shares for an average price of $1.24 since the program was originally announced.

I’d imagine the company will begin repurchasing shares again once sales stabilize and the cash balance improves.

Business Supply Growth

Despite the troubles in housing and construction markets, APT’s Business Supply segment continues to churn out impressive results. The company has managed to operate the segment profitably, growing both top and bottom line results, and has hired additional sales staff to handle expected growth.

The company has also announced a new product offering in the third quarter which should increase market share as well.

Flu Season

In the U.S., flu season is usually marked by the October through May time period. While it is very difficult to predict the severity of the 2010-2011 season, there certainly remains the potential for another significant outbreak.

If so, APT’s products are well positioned to capitalize and provide protection where required.

The buildup in inventory will ensure the company can meet demand without costly production issues if an outbreak requires immediate supply.

Valuation

APT - Stock Valuation

Assuming the company can deliver 2010 EPS of $0.12, the stock is currently trading at a forward P/E level of approx 13, compared to the stock’s long-term P/E average of 19.23.

Assigning the average multiple and the per-share value would be $2.31, right around my estimate.

The stock is currently trading at book value, despite a historical book value multiple closer to 2.5.

NCAV of $1.30 provides a measure of protection on the downside.

Conclusion

With Alpha Pro Tech, the market seems to be keying on the comparable YoY numbers between 2009 and 2010 rather than focusing on a business that has maintained profitability through the ups and downs in its business cycle.

The company’s Building Supply segments has shown exciting growth prospects, and while the loss of VWR’s business is detrimental to sales in the short-term, it might even offer an opportunity for APT to increase its sales network through broader distribution channels.

While $7 is too high for the stock based on current financial performance, conservative estimates peg APT’s value at north of $2.

I’m adding APT to Value Uncovered’s Model Portfolio at $1.58.

Disclosure

No positions in my personal portfolio at the time of this writing.

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8 Responses so far

  1. John says:

    I’ve been a shareholder but sold after latest quarterly results.

    While company remains “profitable”, I’m very worried with the negative operating cash flows. Is the build-up in inventories since Dec 2009 really part of a deliberate strategy? Prefer to wait on the sidelines until situation stabilizes or until the stock trade at appreciable discount to book.

    • asues says:

      Looking at the latest report, the main causes of the drop in operating cash flow were decrease in accrued liabilities and accounts payable and an increase in inventory.

      The timing of accounts payable and receivable can vary from company to company ; however, a decrease in liabilities is generally a good sign as the company works to satisfy its obligations (usually by making a cash payment).

      The inventory increase could be a risk for the company if sales do not return. However, the company did run into issues in its production facility in India last year, causing delivery delays and missed sales opportunities. Assuming the company can move the product, ‘pre-buying’ the inventory going into flu season could provide the assurance that they can meet the sales demand.

      Is it deliberate strategy? Hard to tell definitively but the logic makes sense to me – the coming quarters will tell if management is right.

      In general, I am much more focused on FCF (Owner Earnings), and APT manage to generate over $1m so far in 2010.

  2. John says:

    If I’m not mistaken, accrued liabilities and payables were mostly related to commissions and bonuses due to employees and executives of the company.

    Change in auditor was also a yellow flag that motivated my move. Not saying there is anything wrong here, just prefer watching from the sidelines for now.

    • asues says:

      John,

      Looking back through the financials, approx. $2m was paid down in Accrued Liabilities (mainly commissions & bonuses), with the rest ($2.5m) being a reduction in accounts payable. I’m in sales, and I can appreciate the jump in bonuses for 2009 – I can only imagine what type of commissions would be paid if our sales team blew out their numbers like APT did in 2009! I’m sure the plan has been adjusted in 2010.

      The company’s new auditor is a top 10 accounting firm, so it certainly didn’t take a huge step down from Pricewaterhouse – a quick glance at the auditor’s fees and it looks like the move will save approx $100k. Most micro-cap stocks probably shouldn’t be paying the higher fees for a top 4 firm IMO.

      I really appreciate your insights as it forces me to look at all aspects of my investments. I hope you will continue to comment at Value Uncovered.

  3. Jay says:

    Nice analysis, though one big concern: You seem to look at the 2009 FCF of 7 million as the expectation going forward.
    Looking at APT over the last 10 years, other than in 2009, FCF has ranged from -3m to 3m. If you consider that even that flu epidemics are cyclical, and their building supply unit is cyclical, it seems that 2009 was the exception, rather than the rule.
    Please let me know if I’m mistaken here.
    Thanks for the writeup.

    • asues says:

      Jay,

      If you take a look at the valuation chart, I actually used very conservative estimates for FCF – between $2m and $2.5m. Even using this low estimate and 0% growth, the stock should be worth more than $2/shr.

  4. Jeff says:

    Thanks for the great write-up about APT. I’ve been following the stock and looking for a value analysis like this. Nice to see that my numbers are in-line with someone else’s.

    First time on the blog and will definitely keep reading!
    Jeff

    • asues says:

      Jeff,

      Thanks for your comments. My APT writeup was actually one of my top posts of 2010.

      The stock is up slightly since my initial purchase and I think there is still upside – it remains to be seen how the building supply segment revenue replaces the higher margin product groups. I think the stock should be trading closer to $2 but will be watching the latest quarterly release closely.

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