An interesting but volatile value investment (APT)

Whopper is a deep value investor and the founder of and can be reached at whopperinvestments @ gmail . com

Alpha Pro Tech (APT) develops, manufacturers, and markets protective products (think face masks, eye shields, etc.). On first glance, the company looks a bit expensive. However, this is because their earnings are volatile and are currently at the low end of their range. Despite a history of profitability, the company trades for just 80% of book value and around its net current asset value (current assets minus all liabilities).

The first thing to know about this company is their earnings are very, very volatile. Operating income over the past 7 years has averaged about $4.8m but has come in as high as $13.5m and as low as $1.74m. While this volatility obviously makes the company more difficult to value, it’s nice in a way- it gives the market a chance to over or under react to short term results and thus gives value investors a chance to pick up shares at depressed prices or sell them at rich prices.

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The main question going forward is if the company can return to their previous level of earnings. First, the company’s products (protective gear) are in much higher demand during times of panic or crisis (similar to ABIX, another protective product company mentioned as a potential value investment that subsequently doubled). In a way, this can make the company’s stock act as disaster insurance, as earnings will spike (and thus, the share price could rise) in the event of a disaster, but earnings will remain flattish in normal times.

The other big question surrounding their earnings is their distribution relationship. One of their largest distributors launched their own private label protective products brand. This has cut into APT’s sales with this distributor, as they went from 30% of sales in 2009 to 15% of sales in 2010. In response, APT has announced a strategy to broaden their distribution and has partnered with a major international partner as a result. So far, this has done little to reduce the impact on the company’s top line, but it could be a reason for optimism going forward.

My take

It’s really tough to value this company because it’s so hard to figure out what a normalized earnings number looks like going forward. However, I don’t need a precise number to figure out that they are likely too cheap trading for just 80% book value. To justify trading for less than book value, investors are implying a company will destroy value in the future, either through operating losses are reinvesting at below average ROIC, and APT has no history of that.

For readers who want a precise number, here’s a rough take at valuation. Pre-tax return on tangible assets has averaged just over 16% over the past six years. Applying that to today’s level of tangible assets would give a normalized earnings level of just over $6m. With a current market cap of $30m and EV of $25m, that would imply investors are picking up shares at somewhere between 4-5x pretax earnings, incredibly cheap! Obviously, that valuations a bit rough, but it does speak to a decent degree of value here.

One last note- insiders own over 15% of shares, and the President and CEO are both paid bonuses of 5% of pre-tax profits, so at the very least, insiders have incentives to grow profits. While this isn’t always the best thing as profits can grow at the same time value is destroyed, with insiders holding a substantial equity stake, I’m confident they’ll do it in a shareholder friendly way.

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