2023-06-16 07:00:00 ET
Summary
- Alpha Pro Tech is financially secure for the long term, due to accumulating large cash balances as a result of high demand for its products during the COVID pandemic.
- However, as well as falling demand for COVID related products, its Building Supply segment is now under pressure due a reduction in new building starts that is forecast to worsen.
- After due consideration, the previous Buy recommendation is now downgraded to Hold.
Alpha Pro Tech: Investment Thesis
In my Jun. 21, 2022 article, "Alpha Pro Tech: Time To Buy", I concluded Alpha Pro Tech (NYSE: APT ) shares were a buy at the post market price of $4.00 on June 13, 2022. Subsequently the share price reached a high of $4.99 on Aug. 5, 2022 and a low of $3.88 on Sep. 20, 2022. Again, in my Apr. 5, 2023 article, " Alpha Pro Tech: Buy For A Long-Term Hold Or Short-Term Trading ", with the shares at $4.16 at time of publication, I concluded,
Alpha Pro Tech stock appears to offer opportunities both as a long-term hold or for short-term trading. There has been sufficient volatility in the share price to indicate the possibility of purchasing shares at or around $4.00 and either holding long-term or selling at a higher share price within a reasonably short period of time, with the process possibly being repeated. Whether buying with the intent of a long-term hold or short-term gain there also appears to be the possibility of switching between these strategies depending on future events. The stock should likely remain relatively liquid due to ongoing share repurchases, despite a limited float, but any reduction or cessation of share repurchases would be a matter for concern.
Since that time, the shares first fell below $4 on April 14, providing a buying opportunity at $3.96. The shares then hit highs of $4.15 on April 28, $4.19 on May 9, and $4.24 on June 7. Between these highs the shares traded as low as $3.96 on May 5, and $3.68 on June 2, before rising to $3.82 at close on June 14. Obviously there have been opportunities to buy low and sell high. The major concerns with buying now would be -
- potential inability to achieve a subsequent exit due lack of liquidity in what is a microcap stock.
- any cessation of share repurchases.
- the ability of the company to convert large inventory and receivables balance into cash to fund ongoing share repurchases.
- the net asset backing of the stock.
- curtailment of Disposal Protective Apparel production, including masks, due to high inventory levels and/or declining demand.
- curtailment of Building Supply production due high inventory levels and/or declining demand due a downturn in new housing starts.
Having reviewed all the above, with a further quarter's financial data available since my last article I come to the conclusion it would be prudent to downgrade APT to Hold.
My review is covered in detail below.
Detailed Review
As I have mentioned in previous articles, this is a good and well run little family business. The balance sheet is strong, with no debt. A dividend is not paid and there appears to be no intention to commence dividend payments. Therefore, the only avenue for gain is through share price increases. Idle cash will not drive share price gains, so share repurchases are essential to reduce share count and thus potentially increase market price per share. Areas of concern mentioned above are discussed below.
Share liquidity -
In the current calendar year, total share trading volume through June 13 was 3,820,729, a daily average of 23,731 shares per day. A total of 200,000 shares were repurchased in Q1-2023, which would have contributed to liquidity. Total repurchase amount was $833,000 and average share price paid was $4.16. Repurchases for the June quarter will not be known until the filing of the Q2-2023 10-Q, but $1,362,000 was available for this purpose as of Mar. 31, 2023.
Inventory, receivables and cash · Net asset backing of the stock · Curtailment of operations -
I published a number of articles in 2020 warning of the dangers of buying Alpha Pro Tech at inflated share prices that appeared to assume the COVID pandemic and related high demand for Disposable Protective Apparel ("DPA") would last indefinitely. Chart 1 below shows the rather insane speculative activity in the stock during the pandemic.
Chart 1
Chart 1 does not tell the whole story, as it only reports closing share prices. On Feb. 28, 2020 the share price opened at $37.23, reached a high of $41.59 and a low of $16.61 and closed at $21.00. Total share volume on the day was over 35 million, nearly 3 times total outstanding shares. According to SEC Form 4 filings, sales on that day included 356,667 at $34.49 by APT President and CEO, Lloyd Hoffman, and 357,500 at $38.1299 by Director and Executive Officer, Donna Millar. Donna Millar is the widow of the founder of the company, and according to SEC DEF 14A filing at 28-4-2023 is the single largest shareholder with 1,284,603 shares representing 10.4% of total shares. The only other current 5% holder is Hutch Master Fund with 790,372 shares (6.4%). Ms Millar's shareholding likely allows to influence the composition of the board. My perception is APT is effectively run as a family company with a great deal of loyalty to staff, and this is likely to see operations continue at levels to maintain staffing, which might mitigate against actions to cause an early run down in inventories.
I explained in those 2020 articles to expect APT net income to return to pre-pandemic levels, but by then the company would have accumulated a large amount of cash to repurchase shares. On that premise, the market value of APT was best calculated on the basis of pre pandemic share price levels plus cash per share accumulated during the pandemic. I also noted while the DPA segment of the business lacked ongoing growth prospects, the Building Supply segment showed promise of good growth. In my two most recent articles on APT I have indicated buying APT shares at or below $4.00 per share appeared a fairly safe option as much of the share price was supported by current assets in the form of inventory, trade receivables and cash. I expected post pandemic, both inventory and receivables would progressively reduce to pre pandemic levels, boosting already large cash balances and allowing substantial share repurchases. Table 1 below encapsulates what has actually occurred.
Table 1
SA Premium and SEC filings
Comments on Table 1 -
- Building supply inventory - Inventory has grown at a faster rate than revenue to meet anticipated rapidly growing demand. But, these excerpts from the APT Q1-2023 10-Q filing show a reversal, with demand now falling due to reduced housing starts,
Building Supply segment sales for the quarter...decreased by $1,606,000, or 15.7%, to $8,631,000, compared to $10,237,000 for the quarter ended March 31, 2022... primarily due to a 6.9% decrease in sales of housewrap, a 28.7% decrease in sales of synthetic roof underlayment and a 5.6% decrease in sales of other woven material...segment showed some weakness in sales in the first quarter...due to a significant decrease in demand for new home starts as a result of interest rates hikes and economic uncertainty, as well as high levels of inventory on the dealer and distributor side.. single family housing starts were down 28.6% compared to the same period a year ago. Overall, sales of housewrap products and accessories were down only 6.9%, which is much better than the slowdown in housing starts. Sales of our REX Wrap® and REX Wrap Plus®, our entry level housewrap products, were down 13.0%, despite the major decrease in housing starts as we have continued to acquire new dealers across the country...we continue to make inroads into the multi-family and commercial construction sector as evidenced by an increase of 21.6% in sales in the first quarter of 2023. This is also evident with a 65% increase in sales of housewrap accessories...in the first quarter of 2023. Based on product information provided to a growing number of architects who could specify our products as well as the number of jobs we are specified on and the growth of additional bids taking place, Management expects that we will see positive trends relative to the industry for both our entry level and premium housewrap product lines.
While management has painted a picture of some hope, the following chart of forecast housing starts paints a rather gloomy picture ahead.
Chart 2
It will likely be difficult for management to reduce Building Supply inventories without curtailing production, which would in turn impact on profitability. As mentioned further above, I believe the company will avoid laying off staff if possible. This limits the conversion of inventory to cash and/or limits generation of cash from current operations activity.
Disposal Protective Apparel inventory - After reaching $72 million in 2021, sales are now back to pre-pandemic levels ~$20 million per year, but inventory of $14.2 million is still 2.5 times pre-pandemic level of $5.6 million. The same situation applies as for Building Supply inventory, with lower demand restricting ability to run down inventory without cutting back on production, which might not be an acceptable course for board and management. Given the huge investment by APT, 3M and numerous others in DPA capacity, particularly mask production, at the start of the pandemic, supply is likely to far exceed demand far into the future, putting downward pressure on prices.
Trade Account Receivables - The ~3 million increase in Trade receivables in Q1-2023 is explained in the APT Q1-2023 10-Q filing,
The increase in accounts receivable was primarily related to increased payment terms to our major international channel partner and to higher sales in March 2023 compared to December 2022. The number of days that sales remained outstanding as of March 31, 2023, calculated by using an average of accounts receivable outstanding and annual revenue, was 40 days, compared to 35 days as of December 31, 2022.
No doubt more generous terms are being extended in an effort to move more stock. Despite this, inventory showed minimal decrease in Q1-2023 and the increase in receivables negatively affects the desired conversion of inventory to receivables to cash for share repurchases.
Analysis of share price at period end - Table 1 shows net asset backing (book value) at end of Q1-2023 of $5.03 per share, compared to current stock market share price at Jun. 14, 2023 of $3.82. The stock market share price is analysed to show cash component of $1.14, which is assumed available for distribution to shareholders or for share repurchases. Of the $2.68 per share inventory and trade receivables, it is assumed $1.73 is required as working capital for the ongoing operation of the business. That leaves $0.95 per share attributable to excess inventory and receivables available for distribution to shareholders or for share repurchases. The total of cash, inventory, and receivables that could become available for distribution to shareholders, or for share repurchases is $2.09 ($1.14 + $0.95). On that basis, the value the stock market is placing on the underlying business is $1.73 per share, at current share price of $3.82, with an effective underlying P/E ratio of 9.5. While this 9.5 is below the 12.5 pre-pandemic, it likely should be, given some of the hurdles ahead faced by the company.
Summary and Conclusions
In my previous article I concluded, "Alpha Pro Tech stock appears to offer opportunities both as a long-term hold or for short-term trading. There has been sufficient volatility in the share price to indicate the possibility of purchasing shares at or around $4.00 and either holding long-term or selling at a higher share price within a reasonably short period of time, with the process possibly being repeated. Whether buying with the intent of a long-term hold or short-term gain there also appears to be the possibility of switching between these strategies depending on future events. The stock should likely remain relatively liquid due to ongoing share repurchases, despite a limited float, but any reduction or cessation of share repurchases would be a matter for concern." What has taken place in the interim is consistent with that conclusion.
Following the release of the Q1-2023 results I am rather more cautious on this stock. Both the Building Supply and the DPA segments face significant demand/supply imbalance issues. This could make it a difficult and lengthy exercise to achieve the necessary reductions in inventories and receivables. There is also the potential impact on the profitability of current operations if cutbacks are made in production due to reduced demand and/or to reduce inventories. There is also the possibility of increased bad debts in a recessionary cycle. Despite all of this, given the large cash balance the company is not at financial risk. Taking all the foregoing into account, I downgrade APT to Hold, pending seeing how events unfold over the next couple of quarters,
For further details see:
Alpha Pro Tech: Update And Downgrade To Hold