Canadian cannabis stock Aphria (NASDAQ:APHA) is up more than 90% since the stock market bottomed in March. However, Aphria stock is down 19% since the company reported earnings in late July.
The market was certainly disappointed with Aphria’s earnings report. However, I still believe the company has tremendous long-term potential.
But while Aphria stock has plenty of good things going for it, it has plenty of risks as well.
The Aphria Stock Bull Case
There’s a lot to like about Aphria stock, starting with some of the numbers from the fiscal fourth quarter. Recreational cannabis sales were up 27% from a year ago. That number looks even better compared to the 20% gains in the overall Canadian cannabis market. Aphria is gaining recreational market share from competitors.
Cannabis earnings before interest, taxes, depreciation and amortization margins also improved. Fourth-quarter cannabis EBITDA margins were 17%, up from 11% in the fiscal third quarter. Aphria has now reported five consecutive quarters of positive EBITDA.
In addition, cash burn improved significantly in the most recent quarter. Aphria reported just $37 million in negative free cash flow last quarter, down from $91 million of cash burn in the third quarter. Following the company’s most recent round of bond conversions and equity offerings, net cash at the end of the fourth quarter was $88 million.
So, in one quarter Aphria went from having nearly three times as much cash burn as cash to nearly three times as much cash as cash burn.
Finally, Aphria secured European Union Good Manufacturing Practices certification earlier this year. Cantor Fitzgerald analyst Pablo Zuanic says Aphria is set to launch its international business in Germany in the next six months.
“The German [medicinal marijuana] market remains small with only 0.07% of the population registered (60,000 patients enrolled), compared with 1.8% in FL, 3.3% in AZ, and 6% in OK, but it could see explosive growth as more MDs prescribe MJ,” Zuanic says.
Cantor Fitzgerald has an “overweight” rating and $9.35 price target for APHA stock.
The Risks of APHA Stock
I generally agree with Zuanic’s bullish take. But there are also plenty of reasons not to go all-in on Aphria stock.
First of all, Aphria reported a larger-than-expected earnings per share loss in the fourth quarter of 14 cents. That loss dragged the company’s full-year EPS down to an 8-cent loss as well. To make matters worse, the full-year EPS loss was slightly worse than the 7-cent loss it reported in 2019.
One of the biggest reasons for the disappointing earnings number was a $47.9 million non-cash impairment related to Aphria’s assets in Jamaica, Lesotho, Colombia, and Argentina. Bulls might like to dismiss that impairment as a one-off charge. However, former hedge fund manager Whitney Tilson has a more nefarious explanation.
Back in 2018, Tilson said Aphria “appears to be engaging in massive fraud” related to properties in Argentina, Colombia, and Jamaica acquired from Scythian Biosciences at a premium valuation that benefited company insiders.
In the fourth quarter, write-downs of those same properties were responsible for the lion’s share of Aphria’s net losses.
“Of course, Aphria claims that these write-downs are due to ‘the effects of Covid-19 on the company’s expected cash flows,’ but that’s just an excuse to cover up the fraud,” Tilson says.
Regardless of whether or not the fraud allegations are true, the accusations themselves may be enough to hold the stock back. The entire cannabis industry is fighting an uphill battle against its reputation on Wall Street. Past scandals at MedMen (OTCMKTS:MMNFF) and other companies have investors particularly sensitive to sketchy accounting.
How To Play It
At the end of the day, I see more to like than dislike about Aphria stock. However, there is simply too much risk to go all in on Aphria.
Instead, cannabis investors should consider buying at least four or five Canadian producers and U.S. multi-state operators to reduce risk via diversification. In addition to Aphria, I recommend Cronos (NASDAQ:CRON), Canopy Growth (NYSE:CGC), Cresco Labs (OTCMKTS:CRLBF) and Trulieve Cannabis (OTCMKTS:TCNNF).
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book Beating Wall Street With Common Sense, which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, Wayne Duggan was long CGC.