Despite broader market turmoil, the cannabis sector is starting to heat up again thanks to M&A activity. First it was Canopy Growth (NYSE:CGC), then Cronos (NASDAQ:CRON), and I think the next target is going to be Aphria (NYSE:APHA) stock.
Starting things off, alcoholic beverage maker Constellation Brands (NYSE:STZ) poured $4 billion into leading Canadian cannabis company Canopy Growth back in August. That investment lit a fire under pot stocks as investors bid on who the next M&A target would be.
That enthusiasm waned over time. But, it’s back now, and stronger than ever thanks to Marlboro cigarette maker Altria (NYSE:MO) investing $1.8 billion into Canopy’s peer, Cronos.
Now, everyone is again bidding up pot stocks in an attempt to find the next M&A target, which leads us to Aphria. And there are four big reasons why I think lesser known Aphria stock is the next M&A target in the cannabis space.
First, Aphria has a global and growing production and supply footprint for both medical and recreational marijuana, putting it on the same playing field as the Big Four pot stocks: Canopy, Cronos, Tilray (NASDAQ:TLRY) and Aurora (NYSE:ACB). Second, the company has healthy financials, with industry-leading margins. Third, Aphria has huge production capacity. And fourth, Aphria stock has a market cap of just $1 billion, making it the cheapest notable Canadian pot stock.
Put all those reasons together, and you have a strong case for Aphria stock as the next big M&A target in the cannabis industry.
Global & Growing Footprint for Aphria Stock
Big money is starting to flow into Canadian pot stocks. Part of the reason why is because cannabis is now legal across Canada, and big alcoholic beverage and tobacco companies are eager to get a piece of that pie. But, that doesn’t tell the whole story. In fact, it only tells a small piece of the story.
The Canadian cannabis market represents just a fraction of the global cannabis opportunity. According to Canopy Growth, the Canadian cannabis market accounts for around $10 billion of a $500 billion global opportunity.
As such, big money isn’t moving into pot stocks for Canadian cannabis exposure. It’s moving into pot stocks for global cannabis exposure. Just look at the two companies which have scored big investments thus far. Canopy Growth has production and supply agreements all across the globe. So does Cronos.
And so does Aphria. The company has supply agreements throughout Canada, South America, Europe and Australia. Thus, much like other attractive cannabis M&A targets, Aphria has a truly global footprint that is only growing.
Despite being lesser known than other pot stocks, Aphria is characterized by strong financials which a potential suitor would find attractive.
At its core, this company has industry-average revenues, industry-leading revenue growth, and industry-leading gross margins. Last quarter, Aphria recorded just under $10 million in revenues. That is fairly middle-of-the-pack for the cannabis sector. Canopy and Aurora were up around $20 million to $30 million. Tilray was around $10 million. Cronos was down around $3 million.
Revenue growth was more than 100%, which is at the top end of the group. Meanwhile, this is a company with normal gross margins in excess of 70%. That, too, is at the top end of the whole cannabis group.
The big takeaway here is that Aphria is at or near the top everywhere it matters in the cannabis sector except for raw revenue volume. But, that won’t be a problem for long.
Huge Production Capacity
Aphria is currently limited in its production capacity, with only 35,000 kilograms in annualized production capacity. But, this problem will be fixed shortly thanks to production expansion agreements.
Next year, this company projects to have in excess of 250,000 kilograms in annualized production capacity. That number is huge. By comparison, Cronos has under 120,000 kilograms of production capacity. That is less than half of Aphria’s planned production capacity, and they just scored a near $2 billion investment from a tobacco giant.
As such, this company’s smaller revenue base won’t be smaller for much longer. Once production capacity expands, revenues will start to explode higher. More importantly, this huge production base gives the company firepower to grow globally, and enough firepower to get big money to bite.
Relatively Cheap Valuation
Pot stocks have big market caps. Both Canopy Growth and Tilray have market caps in the neighborhood of $10 billion. Aurora sports a $5 billion market cap. Cronos has a $2 billion market cap.
Compared to its peers, Aphria is pretty cheap. Aphria’s market cap is just a hair over $1 billion.
There really is no reason behind this big discount. Revenues are fairly standard. Revenue growth is industry leading. Gross margins are industry leading. The company has a global and growing footprint. Production capacity is projected to get really big, really soon.
Overall, Aphria at $1 billion and other pot stocks at $2 billion to $10 billion doesn’t make much sense. Clearly, big money believes in the $2 billion to $10 billion valuations for pot stocks because that is where Altria and Constellation Brands have poured in billions.
As such, I expect big money to take advantage of the under-valuation in Aphria stock.
Bottom Line on APHA Stock
Aphria stock, given its favorable fundamentals and discounted valuation, looks like the most likely pot stock to get a big money investment next. As such, buying the stock after its big sell-off but amid rising M&A activity in the cannabis space seems like a solid proposition.
As of this writing, Luke Lango was long CGC, CRON, and APHA.