Editor’s Note: This article was updated on Sept. 20, 2019.
Aphria (NYSE:APHA) is seeing its stock get punished. Shares are down nearly 45% from its February 2019 high. However, APHA is a profitable company which is unusual in the cannabis industry. And if you believe low-end growth numbers, APHA stock is trading at a substantial discount.
The cannabis industry in general has fallen out of favor with investors, but that won’t always be the case. Even if you don’t believe the growth story for APHA stock, the fact that it’s profitable makes it an attractive merger and acquisition target at a time when the industry continues to consolidate.
In an industry where the largest companies won’t be profitable for several years, Aphria stands out. However, that hasn’t mattered much to investors. As we entered the dog days of summer, Aphria stock had declined 42% since the end of February.
In late August, my colleague Chris Lau pointed out that analysts were offering a $10 one-year price target for Aphria stock. That would be over a 60% gain from its current price. Lau also cites a future cash flow model from Simplywall.st that gives the stock a value of $29.35 based on earnings growing at an 80% annual growth rate.
Some of the volatility in APHA stock was the result of it simply being a cannabis play. But there’s more to the story.
In the last 12 months, Aphria has been under the microscope for two of its acquisitions. The first controversy arose after the December 2018 publication of a report by Quintessential Capital Management and Hindenburg Research.
The report alleged that Aphria significantly overpaid for the purchase of Latin American assets. This came on the heels of the company’s March 2018 acquisition of Nuuvera. Observers criticized the move after the disclosure that a few Aphria executives held a position in Nuuvera stock.
Although an internal investigation found that the purchase was on the high end of an acceptable range for the assets, the report was damaging to Aphria’s credibility. This is one reason I think it’s more likely APHA could be a target of a buyout. However, a buyout makes sense for other reasons.
In the last two years, the cannabis industry has entered into an important, yet volatile stage of M&As. For the most part, this stage has involved the major players gobbling up some of the small producers.
The industry is now entering into the main event. Some major players are looking for and needing to show investors a path to profitability. This makes growth through acquisition a viable strategy.
As I mentioned above, Aphria stands out because it is showing a profit. And right now, the stock is inexpensive compared to its production. These two factors make Aphria an attractive takeover target.
However, Aphria is attractive for other reasons. First, it already has access to nearly a dozen overseas markets. And, it has a current run rate of 115,000 kilos. But according to company projections, this rate should more than double once another production facility receives its cultivation license from Health Canada.
Some analysts still view the cannabis industry as the next bubble sector. Many of the largest companies are not profitable. To be fair, for some the path to profitability remains blocked by an unsure regulatory environment. And in the case of the U.S., there is a question of when (or if) full legalization will occur.
However, in an article I wrote about Canopy Growth, I made my position clear. Legalization of marijuana in the United States is a matter of when, not if. There is increasing acceptance of medicinal marijuana and a growing understanding of CBD (the non-psychoactive component of cannabis) that is making the recreational case a more palatable sell.
Despite some controversy (some of which was self-inflicted), Aphria is a profitable company. Like most cannabis firms, much of their recent struggles had to do with delays in green lighting the recreational market in Canada. However, with the market for edibles opening in Canada in October, the time is right to get in on APHA stock.
However, consolidation in the sector is ongoing. And as I mentioned earlier, Aphria may be a takeover target. But look at it this way: even if Aphria becomes an M&A target, what do you have to lose? APHA stock would jump up as part of the deal. Even if you don’t want to hold stock of the new company, you can pocket a nice profit and walk away.
As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.