I’ve been a fan of Aphria (NASDAQ:APHA) stock in the past.
In late 2019, I called it my pick in the cannabis sector. In March 2020, I recommended investors buy the dip at $3.50. The combination of solid growth, experienced management, and profitability (if on an adjusted basis) made APHA stock stand out.
But in April 2021, I’m far less optimistic. Even with a sharp pullback of late, APHA has nearly quadrupled from where it sat in early March of last year. It’s gained a whopping 90% so far in 2021.
The year-to-date gains in particular look a bit questionable. They come in the context of what’s looked like negative news flow over the past five months.
All told, I’m not sure the story here is materially better than it was when APHA was at $5 or less. Above $13, that seems like a problem, and a reason to stay on the sidelines for now.
Is Tilray the Right Partner?
Aphria’s pending merger with Tilray (NASDAQ:TLRY) admittedly makes some sense.
Canadian operators desperately need consolidation amid an ongoing supply glut. The two companies see $79 million in cost synergies achievable within two years. With Aphria profitable on an EBITDA (earnings before interest, taxes, depreciation and amortization) basis and Tilray hitting that bogey in Q4, the reduced costs should get the combined company into net profitability and positive free cash flow.
At the same time, I’m not sure it’s the best deal for Aphria, even if current APHA shareholders will own 62% of the combined company.
I’ve long been a skeptic toward Tilray, whose growth and revenue base hardly stand out among Canadian players. Personally, I’d rather see Aphria go it alone — or look to the unnamed company that too approached Aphria about a merger last year.
Buying the Merger
For a moment, there was a merger-related case for APHA stock regardless.
Thanks to the crazy Reddit-driven rallies in February, the spread between TLRY and APHA ballooned. Both stocks will, assuming the merger closes, end up in the same place. Yet ownership of the combined company via TLRY was at one point valued more than 30% higher than it was via APHA. The spread has since narrowed to less than 2%.
Meanwhile, some of the claims being made about the merger aren’t quite on point. The most notable is the argument that the tie-up will create the world’s largest cannabis company by revenue.
That’s true, technically. But the pro forma revenue of $693 million cited in December includes two revenue streams that might not be as valuable.
First, Aphria has a distribution business in Germany that accounted for more than half of revenue in the third quarter. That business has gross margins of just 13% — and not all of the revenue comes from cannabis.
Second, Aphria also now owns Sweetwater Brewing. That firm generated revenue of $67 million in 2019. Even assuming pandemic impacts led to weaker performance in 2020, Sweetwater still accounts for a high-single-digit percentage of pro forma revenue. I’m not sure its sales are as valuable as those elsewhere in the business.
Weak Earnings
The problem with having any concerns about the merger is that Aphria itself is coming off an ugly earnings report. Yet Aphria is the business that needs to do more of the heavy lifting post-merger.
Results for the fiscal third quarter (ending Feb. 28) were not promising on that front. Net cannabis revenue plunged by nearly one-fourth quarter-over-quarter. Adjusted EBITDA did rise modestly — but thanks to a $4.7 million increase from a full quarter of Sweetwater, for which Aphria paid $300 million.
Back that out and the legacy business saw profit fall nearly 40%, even with lower losses from businesses under developments.
Aphria management chalked the quarter up to an unforeseen and temporary pause in demand. Management might be correct.
Unfortunately, at this point in the growth of Canadian cannabis, it’s pretty much impossible to take management’s word for it (even though I do respect Aphria head Irwin Simon). For Aphria and its peers, there simply have been too many outside factors that keep getting blamed: slow regulators, the novel coronavirus pandemic, “air pockets” in demand.
These businesses have to start growing at some point. Aphria didn’t do so in Q3, and that is a red flag.
Is APHA Stock Cheap?
Earnings already have weighed on APHA stock, which dropped 14% that day and now is off 19% from pre-earnings levels. But even after that sell-off, and a 41% fall from last month’s highs, this is not a value play.
Part of the cause of the sell-off is that APHA got some draft from the Reddit rallies, even if it didn’t move as high as did Tilray. Again, the stock still is up 90% so far this year.
Meanwhile, the combined company would have a market capitalization of around $7 billion at the current APHA stock price.
Each Aphria share will become 0.8381 shares of Tilray stock, on top of that company’s existing share base.
Against pro forma revenue of $693 million, what will be Tilray looks cheap by sector standards. Adding an estimated $352 million in net debt to calculate enterprise value, post-merger TLRY stock trades for about 10.5x EV/revenue.
That admittedly is cheap by cannabis standards. Relative to FY2021 (ending March) consensus estimates, Canopy Growth (NASDAQ:CGC) trades at about 20x EV/revenue, and Sundial Growers (NASDAQ:SNDL) an even higher multiple.
But Aurora Cannabis (NYSE:ACB) is cheaper on that basis — and, again, not all of Aphria’s revenue is created equal. Per the company’s earnings releases, low-margin distribution revenue has totaled nearly $290 million over the past four quarters. That’s 40% of the pro forma total for both companies.
Using pro forma Adjusted EBITDA, even accounting for the cost savings, the combined company’s multiple sits over 50x. That’s not cheap, either.
All told, nothing here really stands out. The company is profitable, but not amazingly so. Valuation is acceptable, but not compelling. Growth looks tepid. A cheaper price helps — but it doesn’t help enough yet.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
