It’s somewhat surprising that Aphria (NYSE:APHA) has held up so well in the last few weeks. To be sure, Aphria stock has sold off sharply in the last two sessions. Coronavirus fears have led investors to a “risk-off” posture, and cannabis stocks across the board have slumped.
APHA hasn’t been spared, falling 8.5% on Friday and 6% on Monday as of this writing. Still, shares are up modestly over the past two months, and flat to where they traded on Jan. 10, two days before the release of fiscal second-quarter earnings.
The reason that trading is surprising is that Aphria’s earnings report, on its face, looks like a disappointment. Most notably, the company lowered its full-year outlook for both revenue and profits.
Yet investors, at least until the last two sessions, had shrugged off that cut — and with good reason. Aphria still looks well-positioned for cannabis growth. Valuation remains reasonable and confidence in the company should increase.
To be sure, risks remain, and it’s possible the sector as a whole has another leg down. But I’ve argued of late that Aphria is the best pick in the industry, and I’ve seen nothing so far in 2020 to suggest otherwise.
The Guidance Cut
Aphria has become an interesting barometer for the cannabis sector. Back in August, Aphria stunned investors by delivering a profitable quarter, if only on an adjusted basis. Aphria stock gained 41% on the release. In less than two months, those gains were erased. Such was the sentiment toward cannabis stocks that even such a milestone was quickly dismissed.
Over the last two months, however, pot stocks stabilized. Aphria earnings now are viewed in a different light. After all, Aphria’s guidance cut was steep: the midpoint of the revenue projection came down CAD$100 million, or about 14%. The outlook for Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) was more than halved.
In 2019, this kind of report would have led Aphria stock, or any cannabis play, to plunge. In 2020, however, investor patience has returned.
To be sure, APHA did decline by 8.4% after earnings. But it had risen over 10% the day before and recouped the post-earnings losses in just five sessions. And that reaction makes some sense.
The guidance cut isn’t welcome to be sure, but it’s not a surprise. And the reduction, per management commentary on the Q2 conference call, largely was driven by external factors. A slower-than-expected retail rollout in Ontario and a temporary ban on vapes in Alberta were two of the key contributors. Obviously, both issues are well outside Aphria’s control — and neither suggests any change to the company’s long-term opportunity.
Slowing growth at the company’s German distributor, CC Pharma, is another source of concern. But remember that Aphria paid just 24.5 million EUR for the business, or about $27 million. Against a market capitalization for Aphria of about $1.25 billion, modest weakness in Germany hardly breaks the bull case.
The Good News for Aphria Stock
Despite the guidance cut, the financials here remain positive. Aphria doesn’t have the debt worries of Aurora Cannabis (NYSE:ACB). The company closed Q2 with CAD$498 million in cash, a sum slightly larger than its borrowings. Aphria stock isn’t necessarily cheap after the guidance cut, but a ~33x enterprise value to EBITDA multiple is reasonable. Aphria’s growth, after all, is not going to stop in fiscal 2021, or fiscal 2025, giving the company a nice path to grow into that valuation.
After all, “Cannabis 2.0” is on the way. And Aphria looks well-positioned in vapes, as a Cantor Fitzgerald analyst noted last week. Edibles and topicals are on the way, according to the second quarter conference call.
The story seems stronger as well. Irwin Simon, a well-respected executive, took the top job on a permanent basis after formerly being the interim chief executive officer. Soon after earnings, Aphria announced a CAD$100 million strategic investment from an institutional investor.
Aphria didn’t necessarily need the cash, but the share sale is a vote of confidence. And it adds to the company’s cash pile, which could be used to buy assets, particularly if valuations in the industry fall even further.
Still the Best Play
And so I believe Aphria remains the best play in the sector. To be clear, that doesn’t necessarily mean it will be the biggest winner. There are arguments to be made for other names.
Aurora no doubt is the highest-reward choice among major players, though it’s also the highest-risk stock in that group. OrganiGram (NASDAQ:OGI) has pulled back after a blowout earnings report this month, and could be an acquisition target. Canopy Growth (NYSE:CGC) has the biggest heft; Cronos (NASDAQ:CRON) has a wealth of options going forward.
But from a risk/reward standpoint, APHA still looks like the most attractive play. The balance sheet is healthy enough to give Aphria flexibility to make an acquisition if one comes along, and strong enough to prevent an outright collapse if sentiment turns.
Positive Adjusted EBITDA suggests cash burn should moderate in the second half of this fiscal year and potentially end during FY21; solvency risk here is immaterial. Leadership in vapes is a plus. So is the company’s exposure to medical markets in Europe.
There’s simply a lot to like here, even if Aphria isn’t quite as splashy as some of its peers. Those peers, admittedly, have advantages in certain areas. Aurora has the largest worldwide reach. Canopy, Cronos, and even Tilray (NASDAQ:TLRY) have cash to spend.
It’s the combination of positive attributes, however, that underpins the bull case for Aphria stock. And recent trading, even though APHA hasn’t rallied, suggests the market is starting to agree.
It’s impressive, in its own way, that Aphria cut guidance and still saw its stock hold up. That’s treatment usually reserved only for quality companies. Aphria seems to be that, and Aphria stock cheap enough if it is.
As of this writing, Vince Martin has no positions in any securities mentioned.
