Investment Thesis

Apollo Healthcare Corp. (“Apollo”) is a leader in the North American private label consumer products and healthcare space and trades on the TSX under the ticker: AHC. Apollo has spent the last few years transitioning its corporate and business operations away from its SPAC roots (prior management’s unsuccessful venture into the aviation finance and private equity space) that burdened the company with debt and significant legacy liabilities.  Through a combination of cost-management, streamlining operations, and a tailwind from COVID-19 induced demand for Apollo’s products (including soaps and sanitizers), the company has: returned to profitability, paid down all the debt resulting from its legacy businesses, and has established the platform for steady growth going forward. While the market has begun to reward Apollo for these changes, the stock price is still significantly undervalued and lacks an institutional following, with zero analysts currently covering the stock. We view Apollo as a compelling investment for 3 distinct reasons:

·         Demand in the personal care space (soap, hand sanitizer) will likely remain elevated in a post-COVID-19 world, especially for trusted producers like Apollo. Even if demand does subside, Apollo’s profitability will be significantly higher than its pre-COVID-19 run rate and it will have accumulated a war chest of cash to deploy into value enhancing initiatives.

·         Apollo has been hard at work restructuring operations, achieving substantial margin expansion and lower SG&A run rate over the past few years. These initiatives caused gross margin to increase from 26% in Q1-2019 to 49% today. Insider buying and high management ownership (~45%) demonstrates management’s confidence in future profitability.

·         Valuation is unjustifiably low, the shares currently trade at a significantly lower EBITDA multiple compared to both precedent transactions and its peers, yet Apollo has better growth prospects in comparison. It was acquired at 8.8x in 2017 by Acasta and its peers are trading at a median of 16.6x. Applying these metrics to current profitability, we believe the stock should instead trade at a $15-$30 range.

Business and Product Summary

Apollo operates under the business name Apollo Health and Beauty. Traditionally a local personal care product developer and manufacturer ran as a private partnership, they are now the largest private label personal care developer in Canada and a major supplier across North America. The company sells various lines of personal care products including liquid soap and cleaners, body wash, hair care, skin care, specialty bath, baby care, nutraceutical supplements, and most recently COVID-19 hand sanitizers. For example, Apollo manufacturers Guard branded hand sanitizers, a common sight in most supermarkets.  

Source: Company Website

The company develops and manufactures these products for a range of retailers such as grocery stores and pharmacies. It provides value to these customers with a leading-edge R&D center, dedicated quality assurance team and innovative custom products.

Featured Apollo Healthcare Clients

Source: Company Presentation

The company is well capable of scaling up capacity with its 486,000 square feet, technically advanced factory located in Toronto. AHC’s ability to seamlessly ramp up production and meet surging COVID-19 demands indicates to us that the factory is well positioned post-pandemic, with significant room for long term capacity growth.

Source: Google Maps

A Troubled History and a Long-Lasting Reputation

The company was initially founded in the early 1990s by brothers Charles and Richard Wachsberg, between its founding and acquisition in 2017, the private partnership grew into one of the largest private label personal care manufacturers in North America. This growth was particularly evident between 2013 and 2015, where we catch a glimpse into the company’s financials, During this period, the company was able to increase sales by 25.7% and expand EBITDA margins from 4.8% to 14.9%. This level of operational excellence enabled Apollo to be recognized for strong management, with it being named Canada’s best managed company for 14 years in a row.

Financial Information from FY2013-FY2016

Source: Acasta Company Filings Link, Link

Everything took a turn for the worse in 2016, when Apollo Health and Beauty was acquired by Acasta Enterprises. Acasta was a SPAC launched in 2015 ran by Tony Melman, a former Onex co-founder who masterminded the Celestica acquisition, paying $750M for the IBM division which was later valued as high as $20B. The SPAC attracted big name backers like former Magna CEO and federal cabinet minister Belinda Stronach, former RBC CEO Gordon Nixon, former Scotiabank CEO Richard Waugh, former Canadian Pacific CEO Hunter Harrison, and other notable supporters. Their names gave Acasta high credibility, and the Canadian market gave it high hopes.  

As with any SPAC, Acasta faced time pressure to deploy their massive pile of cash. By 2016, Acasta decided on three acquisitions, which management believed complemented each other well, they were:

·         Apollo Health and Beauty

·         JemPak, a home product manufacturer that sells laundry care and dishwashing products. Acasta management hoped that complementary products between Apollo and Jempack can drive R&D and process synergies, as well as cross-selling opportunities.

·         Stellwagen, a Dublin based financial services provider for the aviation industry, particularly focusing on aviation financing and asset management.

·         Acasta also launched a separate private equity fund, to further acquire complementary businesses.

The company had originally raised $350M and paid $1.1B for all 3 acquisitions combined, resulting in a heavy bundle of debt dropped on the balance sheet. It’s the age-old private equity leveraged buyout playbook that had worked for Tony Melman before, but not this time.

Fundamentally, these acquisitions were too expensive, and Acasta took on too much debt. The businesses were not as complementary as management originally thought. Criticism was particularly leveled at Melman’s choice to buy an Irish aviation financier Stellwagen, which did in fact cause Acasta the most trouble. Management and the board of directors were distracted trying to fit the pieces together, and as a result growth goals failed and Acasta struggled to support its massive debt load.

The final nail in the coffin was when Stellwagen executives became upset that Acasta was unable to provide additional cash to expand their capital-intensive business, and issued a public statement calling for changes at the board level. Weeks later, Acasta sold Stellwagen back to its management, at only 60% of the price Acasta had bought it for, excluding significant operating losses during the period they owned it. Tony Melman and his team of CEOs started checking out one by one. In June 2018, JemPak was sold as well. By then, Apollo Health and Beauty was the only business left in Acasta’s portfolio. At Apollo, while the core products remained strong, cash was diverted to fund other businesses in the portfolio and Melman’s team made poor sales and financial decisions. There wasn’t much the company could have done during this time under the constraints of Acasta management.

Apollo’s stock price went from around $10 originally to $0.85 by year end 2018.

Acasta was Canada’s largest SPAC at the time backed by industry heavyweights, so its downfall captivated investors and was heavily covered by the media. After 2018, the attention stopped and the message understood by the market was that Acasta had high hopes but ultimately failed, which is how the story ends. However, the story didn’t end there, and the cleanup work done by the Wachsbergs since had largely gone unnoticed. We believe investors are overlooking the impressive recovery Apollo had been able to mount for the past 2 years, resulting in its exceptionally low valuation at the moment.  

The Recovery Period, and a Helping Hand from COVID-19

By 2018, Apollo was in poor financial shape and losing money. On December 21st 2018, it was announced that the original founders the Wachsberg brothers would take control of Acasta, a new board of directors was appointed and the Wachsbergs became co-CEOs. They owned 36% of Acasta stock at this point.

The company was restructured throughout 2018, but still ended the year with over $70M of debt. Current liabilities were over $110M while current assets were just $65M. Its assets barely covered liabilities and shareholder equity was at its low point. Simply put, the balance sheet was in an ugly position.

With the new year coming, the Wachsbergs quickly got to work, now back at the helm of their own company. Within 3 months of this new management, the company was able to turn a small profit in Q1 2019 for the first time in 2 years. This was a start and with continued focus on operations, the company eventually turned around.

Since the Wachsbergs took over, gross margins expanded from 26% to 50%, and Adjusted EBITDA margin posted similar increases. Even prior to COVID-19 driving up demand, the company had been ramping up profitability. Note – in Q4 2019 the company posted slightly negative EBITDA. During the same quarter a one-time charge of $3.1M of executive award related to restructuring work was included.

Financials, 2019-Present

Source: Company Filings

However, debt remained a major issue at Apollo. In 2019, the Wachsberg brothers used WFI Inc, their own financial company, to pay off AHC’s bank debt. The refinancing essentially transferred debt from the banks to the managers themselves. We note that the WFI facility is interest free. We see this as a definitive show of commitment to the company by the Wachsberg brothers.  

Source: Company Filings

In another vote of confidence, the Wachsbergs has recently acquired over 2 million shares. (Link and Link). They are well aligned with shareholders as they own almost 50% of the company.

Source: Sedi.ca

Despite financial improvements and such management actions, the stock did not react and has in fact continued to decline. Even when COVID-19 initially took hold, the market somehow did not realize the pandemic’s implication for Apollo, a soap and hand sanitizer company. It wasn’t until Q2 results were released on August 11th 2020 that investors finally took notice. That quarter, the company expanded revenue by over 240% and EBITDA by almost 1000% YoY.

As we see in the financials above, the company was able to double its revenue without the corresponding increase in fixed and variable costs. Improving both its contribution margins and bottom line. Increasing gross margin from the mid 20% range to almost 50%, and EBITDA from sub-10% to over 30%.

We believe Apollo is not a one trick pony, and it will continue to excel in a post-pandemic environment. Firstly, many of the operational efficiencies gained during the pandemic will likely remain. Secondly, it is unlikely that demand for its products fall back to pre-COVID levels, as the general population becomes more accustomed to personal hygiene and sanitization. Finally, as the COVID-19 vaccine rollout is not expected to be widely available in North America until at least the second half of 2021, Apollo has lots of time to shore up a large capital base to fund additional growth. Whether this growth will be via organic means or acquisitions we can not say, but it does give management ample optionality going forward. Furthermore, as the Wachbergs are major shareholders themselves, Apollo will likely be moving towards returning some of that cash to investors as well, either in the form of dividends or buybacks.

Depressed Valuation Provides an Optimal Entry Point

Apollo’s valuation is extremely low both compared to previous multiples given during the 2017 Acasta acquisition as well as peers multiples.

Peer comparables

Source: Capital IQ

Comparing to competitors in both the private label and global branded personal care product space, AHC is significantly undervalued. Apollo generated $61M in unadjusted EBITDA, and at the set median multiple this implies a $14.2 share price, representing a 260% upside.

Note that Apollo’s financial performance has significantly improved over the last 2 quarters as a result of COVID induced demands. In the most bullish case where we assume demand remains elevated in a post-COVID world, even with no further operational efficiency improvements we see the company valued upwards of $25+ share if we apply peer multiples to an annualized estimate based on last 6 months’ EBITDA.

Source: Company Filings, Capital IQ

Precedent Transaction

When the company was acquired by Acasta in 2016, the deal was done at an 8.8x adjusted EBITDA multiple.

As we discussed previously, Apollo deteriorated significantly under Acasta management. However following restructuring and improvements, we believe the company is in a better shape today than it was in 2016. Gross margins expanded from 33.1% in 2016 to 40.5% LTM, Adjusted EBITDA margin is around the same in 2016 and LTM.

Therefore, we believe that using the 8.8x multiple from 2016 represents a base valuation for AHC today.

Conclusion and Recommendation

We see Apollo as a stock that’s been wrongfully neglected as a result of its troubled history. The company had been working behind the scenes for the past few years optimizing their operations and COVID-19 provided the perfect opportunity for management to prove how scalable their new operations are. The fact that Apollo was able to swiftly ramp up production as well as continue to deliver higher margins amid increased demand is a testament to the company’s recovery.

The market has yet to fully appreciate the new Apollo though, and the stock is still significantly undervalued. Despite strong financial performance, paying off all its debt from cashflow in 2020 and a favorable industry environment, it still trades significantly below peers and below its own acquisition multiple from 2016. We see the company as the strongest version of itself and poised to deliver cashflow to shareholders in the future, potentially in the form of dividends or share repurchases.

Apollo’s depressed valuation hints that the market still suspects the company is just a one-time beneficiary of COVID-19 demands instead of a manufacturer with long term potential. We highlight that the company was able to ramp up revenue without corresponding increases in variable and fixed costs, indicating that fundamental operations at the company today is much better than it was two years ago. These improvements will not go away post-COVID-19. In addition, the pandemic will likely continue to provide increased sales in the future due to general societal awareness regarding personal hygiene. Lastly, even if demand flatlines post COVID-19, we note that the company will walk away with a large pile of cash, well positioned to further expand margins, make capital investments, or explore accretive acquisitions that complement the business.