Alpha Pro Tech: Good Level For Decent Returns (NYSE:APT)

Business

Alpha Pro Tech (NYSE:APT), incorporated in 1994 and headquartered in the State of Delaware, is in the business of protecting people, products and environments. Products include a high-value, disposable protective appealed and infection control products for the cleanroom, industrial, pharma, medical and dental markets. APT also manufactures building supply construction weatherization products.

Building Products: Weatherization products such as housewrap, housewrap accessories, synthetic roof underlayment and woven material. APT is considered one of the leaders in the side wall envelope market, with the strength lies in the warranty systems offered by purchasing and installing wrap, flashing and tape during the construction process. APT also manufactures five different nail based synthetic roof underlayments with the success based on the timely delivery of high quality products. Building products are manufactured in in a company-owned facility in Georgia as well as through an Indian JV (41.6% ownership).

Disposable Protective Garments: Complete line of disposable protective garments (shoecovers, bouffant caps, coveralls, gowns, frocks and lab coats). Coveralls and lab coats are essential in the life sciences marketplace. Shoe and boot covers in a variety of materials and tile options meet customers diverse applications. APT has been in the face mask manufacturing business for over 30 years. The vast majority of the disposable protective garments are manufactured through the Indian JV and to a much lesser extent by other contract manufacturers in Asia and Mexico. Face masks are primarily manufactured in Salt Lake City (Utah). Eye shields are produced in APT’s facility in Nogales (Arizona) and assembled by a subcontractor in Mexico

U.S. accounts for 98% and 96% of sales in FY22 and FY21 respectively. APT rely primarily on a network of independent distributors for the sale of products. The Company doesn’t have backlog orders and most orders are shipped within 30 days. Appropriate levels of inventories are maintained to supply distribution on a timely basis. All pricing and payments are in USD.

Market

The weatherization products are sold to construction supply and roofing distributors while disposable protective apparel products are sold to the industrial, cleanroom, medical and dental markets.

The company faces significant competition from companies such as DuPont in the weatherization market, Berry Global for housewrap, Ownes Corning and GAF for synthetic roof underlayment and Kimberly-Clark for medical and dental markets. APT also competes against 3M, Johnson & Johnson, White Knight Engineered, Cardinal Health and Medline Industries. It goes without saying that there is a massive difference between APT and some of the competitors regarding financial strength and resources.

Management

Lloyd Hoffman, the CEO, has been employed by the Company since 1991 covering accounting and finance roles until becoming the CFO in 2022. Mr Hoffman was appointed CEO in Jan-16. Colleen McDonald joined the Company’s accounting department in 1995, was named Assistant Corporate Controller in 2002 and has been the CFO since Jan-16. Danny Montgomery joined the Company in 1994 and has been the Senior Vice President of manufacturing since 2007. Generally, we like to see a long-term commitment from the management team.

The three executive officers combined was rewarded a salary of $1.3m in FY21 and a total compensation of $2.1m which could be considered high for a company that generates $3-5m in operating profits.

Mr Hoffman is eligible for an annual discretionary bonus of up 5% of the Company’s earnings before tax to a maxim of $1m. Which mitigates the risk of excessive bonuses and partially aligns shareholders interest.

Directors and Execs combined hold 13%, with Donna Millar (Investor Relations) holding 9.9%! While is not great to see CEO and CFO holding only 164k and 47k share respectively, at least there is someone with significant skin in the game.

It is worth noting that both the management and the non-exec team are not in their primes. The average age of the executive officers is 61 and the average age of the non-execs is 68.

Capital Allocation

Growth Capex: The company is increased production capacity in Building Supply segment by investing c. $4m in new equipment, a part of which became operational in the latter part of the 3Q21. The remaining equipment delivered in Jan-23 (as opposed to 2Q22 guidance) and partially became operational in 1Q23, driving further capacity.

Share Buy-Backs: In Dec-22, BoD authorised a $2m expansion of the existing share repurchase program, which combined with the $0.4m from the previous expansion (Announced in Jun-22), makes for $2.4m of fire power. Management is buying back shares since FY11 with the total number of shares outstanding reducing from 22.1m in FY11 to 12.7m in FY22. A serial stock repurchaser!

Risks

Competition: The former largest distributor of APT’s products, VWR International, is now one of the major competitors in the industrial and cleanroom market while continues to distribute APT products. Cardinal Health and Medline Industries, two other competitors, also distributes products for APT. Appreciate that given the size of the company makes sense to use third-party distributors but having your competitors distributing your products raises some serious concerns. Probably need to further investigate that relationship.

Client Concentration: The top 3 customers accounts for 45% and 40% of sales in FY22 and FY21 respectively. On receivable side, the biggest customer (20% Sales) is responsible for 45% of accounts receivables in FY22 up from 13% in FY21. In FY22 accounts receivables increased by $2.2m (+46%) to $6.9m mainly due to increased payment terms to APT’s largest international partner. As a consequence, receivables days increased from 24 to 35.

Sourcing: The majority of disposable protective apparel products are manufactured by contract manufacturers in Asia (mainly the Indian JV) with certain proprietary products are being made in Asia using materials supplied by the company. COVID created significant challenges to the global supply chain and while India doesn’t have the same country risk as China, I still believe that the Asia-sourcing model could be under question.

Overall Thesis

Building Supply sales increased marginally in FY22 due to softening in the building industry, resulting from a slowdown in the newbuilds and re-roofing expenditures as well as inventory stockpiles at the dealer side. According to the management, economic uncertainty could hit FY23 sales, which currently sit to an all-time high level. However, segment sales is on an uptrend increasing from $25m in FY17 to $37m in FY22 (5Y CAGR @ 8.1%).

“We have experienced the five highest quarters on record for the Building Supply segment over the past seven quarters: the first, second and third quarters of 2022 and the second and third quarters of 2021.” – 4Q22 Press Release

The performance of the Disposable Protective Apparel segment in FY20 was exceptional, boosted by the COVID developments. Segment sales reduced from $102.7m in FY20, to $31.7m in FY21 to $25m in FY22, still above the FY19 level of $20m. The decline in FY22 was driven by the 10.7% decrease in sales of disposable protective garments, the 43.8% decrease of face masks and the 25.6% decrease of face shields. It is a bit more challenging to estimate the sales going forward but the segment was also on an upward trend since FY17 (5Y CAGR @ 5.2%).

Overall, consolidated net sales in FY22 decreased by 10% to $62m following a decrease of 33% in FY21, from $102.7m in FY20 to $69.6m. The decrease was mainly due to the $6.7m sales decline in the Disposable Protective Apparel segment which followed a $40.4m sales decline in FY21. The $55-60m sales is a good base going forward based on the financial history.

Historically, APT was generating EBIT% @ 6-7% with the exception of FY20 and FY21 which generated 30.8% and 11.5% respectively. We could assume some efficiency improvements but there is no indication that APT could hit 9-10% operating margins any time soon.

As per the financial history, WC could be lumpy at times. Excluding WC movements, APT generated $37m in cash from operations over the last 10 years, excluding FY20. Capex requirements are broadly minimal at $500-600k per year. That said, APT generated an average of $3m in FCF. The cumulative $37m number matches exactly the dollars spent on share buy-backs. In other words, management rewarded the shareholders with the totality of cash generated over the last 10 years.

APT has a clean balance sheet with zero debt, c. $2m leases and $16m in Cash, which offer significant downside protection.

Going forward and through the current economic downturn, if we assume that the company could continue to increase sales at 3-4% per year and generating a reasonable 7% margin, it would be in a position to generate $4-4.5m in FCF in FY25-26. Which could imply a value of over $6 per share (50-60% upside), without taking into consideration the share-count reduction, which could add a further 5-7% per year.

Last but not least, a buyout should not be a surprise since the management team is quite old, there is no shareholder with controlling interest, there is no debt and a PE firm could cut at least the total compensation expenses realising immediate value.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.