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

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

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.

NexCen Brands Inc (NEXC) is a brand management company holding 7 brands in two different operating segments: quick service restaurants and footwear & accessories.

Across the brand network, the company operates approx. 1,700 retail stores for brands like Great American Cookies, Marble Slab Creamery, and The Athlete’s Foot.

The current arrangement provides another special situations investment opportunity, with the company’s liquidation providing potential returns for the patient value investor.

History & Financial Situation

NexCen purchased the rights to the seven brands back in June 2006.  Since then, the stock has plummeted, as the company has lost money every year since 2005 while book value per share has been negative since 2008.

NEXC took on a great deal of leverage as it expanded its brand portfolio, borrowing over $138m under its credit facility in 2008 in order fund the acquisition of Great American Cookies.

However, the investment did not pay off, and the company struggled under the debt burden, casting doubt over whether it could continue as a going concern.

From the most recent 10-K, NEXC’s

“Credit Facility obligates us to make a scheduled principal payment of $34.5 million on our Class B Franchise Note in July 2011. We currently do not hexpect that we will be able to meet this obligation.”

As a result of the debt load, the company began seeking strategic alternatives for its debt and capital structure with the goal of maximizing return for shareholders.

Strategic Asset Sale

On May 13, 2010, NEXC announced an agreement to sell its franchise businesses to an investment firm with significant franchise experience for $112.5m, subject to stockholder approval. The proceeds would be used to pay off the company’s credit facility.

The definitive proxies for the transaction were filed on June 11, 2010, with special shareholder meeting scheduled for July 29. The proxy described the asset sale of the majority of the company’s assets, followed by a dissolution and liquidation of the company.

On July 30, 2010 the shareholders voted to approve the sale and dissolution proposal, effectively ending the company’s status as a working business.

NEXC Plan of Dissolution & Liquidation

According to the proxy filings, the company expects liquidation distributions in the range of $0.12 to $0.16 per share.

The stock is trading only slightly above the low point of the estimated range, providing a downward floor from a risk perspective but with significant upside.

Potential Catalyst

Further increasing the chances that the company will end up distributing cash towards the high end of the range, NEXC announced the hiring of a strategic consulting firm who will handle the wind-down of the company, including the distribution.

The fee for this service is $100k, money that could potentially go to shareholders. However, I like this arrangement because the terms of the agreement provide an incentive fee in the event that at least $8m is distributed to company shareholders.

I’m a big believer that people will focus exclusively on what they are incentivized to do – in this case, it should influence the consulting firm to quickly wrap up the transaction in a timely fashion and for the lowest cost.

Since the biggest risk in these transactions is the final closing being bogged down in legal and logistical nightmares that take a great deal of time, I view this arrangement as a very positive development for shareholders.

Return Scenarios

Major Risks

Although the company is estimating the low range of net proceeds to be $0.12, there remains the possibility that shareholders might not receive any compensation at all.

Also, despite the consulting arrangement, these type of liquidations can sometimes take years to wind-down, as the company pays down creditors and satisfies remaining obligations.

Conclusion

While there is definite risk in the deal, substantial upside remains if the consulting company can finalize arrangements in an orderly and efficient manner (right in line with their incentive arrangement).

I believe that the firm will do everything in its power to reach their success target of $8m, allowing for a potential return of 12.14%.

I’m adding NEXC to the Value Uncovered portfolio at Friday’s closing price of $0.123. The record date for the liquidation distribution is today, Sept 13.

Disclosure

Long NEXC

The equity markets continue to be rocky as August finished up, with the S&P 500 dropping 4.5%.  The Value Uncovered model portfolio followed the market down as well, dipping into the red for the first time since inception.

Stock Positions

August was another very busy month on the earnings front, as many stocks reported their results for the quarter ending June 30^th.

After turning in a great second quarter (including a nice special dividend of $1/shr), SPAN followed by reporting tough 3^rd quarter results.  The stock was the biggest loser in August, dropping below my initial entry point back in October of last year.

With dividends included, the position in SPAN is still positive and I expect a big fourth quarter.

Both APNC and TPCS reported solid results, with TPCS reporting a huge jump in revenue while APNC chugged along with another increase in quarterly net income.  ADVC continues to hum along as the tiny software company that nobody is talking about.

CHBU reported a ridiculous 300%+ growth in sales, and the stock still trades for less than net cash.

NOOF was the biggest gainer in August, up over 16%, as the stock finally rebounded from its 52-week low.  Another bout of insider buying helped add credibility, and the company finally seems to be turning a corner – NOOF is too cheap to remain below $2 for long.

Despite going through hundreds of financial statements, only one stock met my criteria for investment, as I added DIT to the model portfolio.  The stock is a great turnaround story, and I believe management will continue to consolidate and grow in a very competitive business.

Special Situations

FIS was another successful special situations investment that took advantage of a major recapitalization plan and self-tender offer.  The position netted a 4.69% gain in a little less than a month, for an APY of 81.8%.

However, another special situations investment is in big trouble – EMMS.  Jeff Smulyan, the company’s CEO, has run into all sorts of problems with taking the company private.

Details are still very sketchy, but the deal looks to be in serious jeopardy.  I find it hard to believe that Smulyan would let this same situation happen to him again (he tried to take the company private a few years ago and failed), but it looks like the market expects it to fall apart.

I will be monitoring the situation closely and may be forced to sell at a substantial loss.

Performance

The portfolio slipped into negative territory YTD, but is still ahead of the S&P benchmark.  Check out my holdings page for a full rundown.

As all of these investments are in micro-cap stocks, often with little or no liquidity, the market fluctuations can have significant impact on the portfolio’s return over a given month or even quarter.

Although I’m disappointed in the monthly results, it is more important to look at the portfolio over a longer time period.  I am constantly reevaluating my positions and will make changes as needed.

Final Thoughts

Also, I am considering slightly modifying the structure of the Value Uncovered portfolio to keep track of cash balances (see an example here from the wonderful blog, the SINLetter)

For a model portfolio, this new structure should provide a more accurate portrayal of real investment returns while allowing me to accurately represent position sizing.

I hope to make the changes soon.

Disclosure

Long SPAN, TPCS, APNC, ADVC, CHBU, NOOF, DIT, EMMS