Aphria Stock Isn’t the Way to Play Marijuana Legalization

With investors excited about U.S. federal pot legalization, major cannabis equities remain elevated. That includes Aphria (NASDAQ:APHA) stock. But, while the Canada-based cannabis company offers exposure to possible changes in U.S. marijuana law, it may not be the best way to wager on it.

APHA stock
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Blame it on its pending merger with Tilray (NASDAQ:TLRY).

Sure, this deal could pay off in the long run. But the structure of the deal limits how much this stock can gain going forward. With the transaction structured as an all-stock deal, APHA stock will continue to move in tandem with TLRY stock until the deal closes. Yet, with Tilray already overly inflated by last month’s meme stock mania, subsequent gains may be minimal.

Also, even as investors have priced in a substantial merger spread into the deal, that doesn’t mean there’s less downside risk here. Shares could still take a dive, whether due to the merger getting scrapped. Or from Tilray falling back to lower prices.

So, what’s your best move? Look elsewhere for a legalization play.

APHA Stock and Legalization

Marijuana investors celebrated when Democrats took control of the Senate and the White House in January. They were certain that rapid legalization of recreational marijuana in the U.S. would be a top priority.

But it’s still a long shot whether “blue wave” equals a fast track to legalization. Sure, now with the much-anticipated Covid-19 relief package signed into law, Congress has more time to hammer out possible reforms to America’s pot policy. Even so, President Joe Biden remains more in favor of decriminalization than legalization. That is to say, we may wind up not seeing the types of changes needed to allow Canada-based pot giants to enter this U.S. market.

Yet, if we see some progress in 2021, expect another round of outsized moves for some pot stocks. However, perhaps not for Aphria. Despite trading for a lower valuation than its peers, the Tilray merger caps how much APHA stock can gain from here.

Coupled with the big downside risk from this deal (which may not pay off), this is far from being the best pot legalization play out there.

Shares Are Deceptively Cheap

As InvestorPlace’s Vince Martin broke it down on March 4, markets have priced in a substantially wide spread into the pending Aphria-Tilray deal.

The transaction is structured as an all-stock merger, with Tilray the surviving company. Shareholders will receive .8381 shares of Tilray stock for each share they own of APHA stock. As is typical for pending merger deals, there’s a spread between the trading price of the acquiree and the trading price of the acquirer.

Typically, this spread is in the single digits. But, in this case, it’s well into the double- digits. In short, that means buying APHA stock today basically allows you to buy TLRY stock at a healthy discount. This may lead some to think this is a cheap way to bet on pot legalization.

The theory that Aphria is a cheap legalization play is boosted by low valuation, relative to both its soon-to-be-acquirer, along with peers like Canopy Growth (NASDAQ:CGC). Right now, this pot stock trades for an enterprise value-sales ratio of 14.6x. Pricey, not as pricey as the forward EV-sales multiples of both Tilray (25.4x) and Canopy (31.8x).

Yet, this valuation discrepancy is perfectly rational. First, the spread could narrow, but it’s highly unlikely it’ll go from being at a discount to the exchange offer, to being at a premium to it. That’s what would happen if Aphria shares suddenly experience massive multiple expansion.

Second, its “cheapness” doesn’t mean it has less downside risk. If the Tilray deal gets called off, the stock would see an immediate drop in price. Even if the deal’s still on track, a big pullback in TLRY stock would take APHA stock down with it.

In short, there’s little advantage to buying this, compared to other pot plays that also have legalization exposure.

Stick to Other Pot Stocks

Aphria may be a great opportunity for those bullish on the Tilray merger. If the deal pays off, the combined company could end up worth substantially higher than either piece is worth today.

But for those just looking for a general pot legalization play, this may not be your best option. Instead, check out other reasonably priced names and steer clear of APHA stock.

On the date of publication, Thomas Niel did not (either directly or indirectly) hold any positions in the securities mentioned in this article.

Thomas Niel, a contributor to InvestorPlace, has written single stock analysis since 2016.


Article printed from InvestorPlace Media, https://investorplace.com/2021/03/apha-stock-isnt-the-way-to-play-marijuana-legalization/.

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