Alpha Pro Tech (NYSEAMERICAN:APT) is a very profitable maker of face masks and other personal protection equipment (PPE). APT stock looks it will be a winner at least over the near term as cash flow surges from increased spending on gowns, coveralls and face masks.
For example, last quarter alone the company generated over $9.1 million in free cash flow from massive orders for its PPE and related items. That includes $5.3 million in net income and a net advance payment of $4 million in orders for PPE.
This may not continue every quarter as Q1 might have been an anomaly. However, I suspect that cash flow will still be higher than net income for the foreseeable future.
Long-Term Assumptions on FCF
Therefore, it looks like Alpha Pro Tech could be generating at least $30 million in free cash flow (FCF) for the next year or two. This is important because the market cap may not be as expensive as it appears.
To be sure, Alpha Pro Tech stock has risen six-fold in the past seven months, from $3.50 a share in mid January to yesterday’s $22.94 closing price. Moreover, the market capitalization has risen from $47 million to over $303 million.
But FCF increased from negative $1.5 million a year ago to $9.1 million in Q1. Annualized FCF yield is now at an attractive rate of about 10%, calculated by dividing the estimated $30 million in FCF this year by the $303 million market value.
Even if the company experiences lower orders over the next several years, I suspect that there will be heightened concern by hospitals, medical facilities, governments and large corporations of another resurgence of the novel coronavirus. That will likely lead to an ongoing set of orders for its PPE for a good while to come.
Valuing APT Stock
To properly value APT stock, let’s make two assumptions. First, let’s say that the company has normalized annualized FCF of $20 million to $25 million over the next three to four years. Second, we can assume that a normalized FCF yield should be between 5% and 7%.
This leads to the following valuation. Taking $20 million in FCF and dividing it by 7% results in a market capitalization of $285 million. With $25 million in FCF, the market cap is $357 million.
Moreover, if we value $20 million in FCF at 5%, the market cap should be $400 million. With $25 million and a 5% yield, that value is $500 million.
Therefore, the range of valuations is from $285 million to $500 million. The average of these four valuations is $386 million. Since there are 13.578 million shares outstanding, that target price per share is $28.39, or 24% above the price of APT stock from current levels.
What to do With APT Stock
Just because we think APT stock is worth 24% more does not mean there will be a chance that the stock will rise. For one, I think the defensive investor will want to see if Q2 earnings seem to confirm our fundamental thesis.
That thesis is that the company should generate between $20 million and $25 million in FCF annually. Earnings for Q2 will likely be released during the first week of August.
Second, there should be a catalyst that will push the stock higher. Otherwise, there might a number of sellers who have made a good amount of money, including insiders, who want to keep selling their Alpha Pro shares. In addition, everyone already knows that we are experiencing a resurgence in Covid-19 disease. That is already in the stock price.
Moreover, hospitals have already made their orders. However, there are still reports of medical facilities having major shortages. Unbelieveably, some facilities have had to reuse and share their PPE and face masks. Nevertheless, I believe the orders will continue to be strong for the company over the next several years. That could be a sufficient catalyst for the stock to rise to its target value.
Therefore, look for opportunities to buy APT stock on weakness. For example, after the earnings are released, investors may take profits. That might be a good time to take a position in this interesting stock.