Description

Alpha Pro Tech (APT) was written up on VIC in July 2021 at $6.99 per share. The stock quickly ran up over $10 before starting a steady decline. It has traded mostly flat between $4 and $5 since January 2022 and currently sits at $4.31. 

Trading slightly above net current asset value with a profitable business, hugely net cash balance sheet, and rational capital allocation strategy, I believe APT is undervalued with well-protected downside and meaningful potential upside.

APT is a two segment business, both of which are quite boring. 

The Disposable Protective Apparel (DPA) segment manufactures and sells single use protective products like face masks and shields, coveralls, bouffant caps, and boot covers. These products are manufactured in leased facilities in the U.S., Mexico, and India (via JV) and are sold through distributors mostly in the United States. DPA products are used primarily in cleanrooms, industrial safety manufacturing environments, hospitals, laboratories, and dental offices.

DPA sales have been relatively stable over time with occasional sharp increases during periods of viral outbreak, such as SARS in 2003, H1N1 in 2009, and COVID-19 in 2020. The economy and general industrial manufacturing in the US also impact demand for DPA products.

The Building Supply Products (BSP) segment manufactures and sells housewrap, roof underlay, window tape, and other woven materials used in the building of new homes. Manufacturing is done in the US and India and products are sold primarily through distributors. The BSP segment was started from scratch in the mid 2000s and has grown at a 14% CAGR since 2007. It is cyclically tied to US homebuilding but has done better than the industry starting from a small base.

Both the DPA and BSP segments face near-term headwinds. Excess DPA supplies following the end of the pandemic will take time to burn off; however, non-mask sales have been strong which has dampened the blow to the DPA segment. 

Homebuilding has slowed with rising interest rates. APT will likely continue to do better than the industry average as they are adding distributors and still make up only a tiny fraction of the market.

Both segments sell products with lots of competition and minimal differentiation. Reliability and specialty features offer small opportunities for improvement, but these can be copied by others. For example, APT’s roof underlay products feature high traction material with pre-printed nail holes that make for safe and easy installation. These are nice features and the higher upfront material cost is more than justified by gains in safety and efficiency, but competitors can come up with similar features given time and energy.

While APT has a respectable brand with a multi-decade history of profitability, it is not an outstanding business. Average ROE is in the high single digits. Demand fluctuates with domestic industrial activity, viral outbreak, and new home building, and supply is full of worthy competitors and substitutes. This isn’t a franchise business, but it isn’t a cigar butt either.

APT has a market cap of $56mm and enterprise value of $32mm. Trailing sales, EBIT, and NOPAT are $62mm, $4.7mm, and $3.7mm, respectively. EV/sales is 0.52x, EV/EBIT is 6.8x, and EV/NOPAT is 8.6x. NCAV per share is $3.77 (1.14x) and TBVPS is $4.85 (0.89x). APT looks cheap on all of these metrics.

The company uses all FCF to buy back stock, regardless of the share price. As such, diluted shares outstanding have declined from 27.1mm in 2006 to 12.9mm at present (52% reduction). In the first three quarters of 2022, APT bought back 665,000 shares for $2.8mm.

There is also an interesting element of optionality with APT. During prior periods of contagion, APT’s operating results and stock price both increased dramatically. In 2003 (SARS), face mask and shield sales grew 88% and the stock went from $0.80 to $3. In 2009 (H1N1), total sales grew 67% and the stock went from $0.95 to well over $6. In 2020 (COVID-19), sales were up 120% and the stock went from $3.40 to nearly $20. The shares are now back down near 2019 levels despite more cash and book value per share. 

I believe it is likely that the next period of viral outbreak will result in frenzied demand for APT shares (as has happened in all prior observable periods). To illustrate, if TBVPS grows at 8% for the next 15 years, at which point there is a viral outbreak and APT trades up to 3x TBV, the stock will sell for $46 (17% CAGR from the current price).

The prior VIC write up discussed APT’s attractiveness as an acquisition target. The merits mentioned there still hold. I think private equity would be happy to buy this business, right-size the balance sheet, and cut corporate costs (which are likely much too high at $5mm per year). A strategic acquirer like Tyvek or Cardinal Health could also buy Alpha Pro Tech and achieve some SG&A as well as manufacturing savings.

The main risks are that 1) APT is a relatively mediocre business, 2) the next outbreak could take a long time to materialize, and 3) when it comes there may be less enthusiasm for APT shares than in prior periods. If any or all of these risks play out, shareholders could be stuck with a dead money kind of stock. Nevertheless, I believe downside is sufficiently low and potential upside sufficiently high. When you are unlikely to lose money the other alternatives are usually pretty good.

Catalyst

• Buybacks
• Viral outbreak
• Rebound in homebuilding
• Merger