Down 14% in 2019, Is Pot Stock Aphria Now a Buy?

When the year began, cannabis stocks were expected to pick up right where they left off the previous three years. In other words, it was expected to be another banner year for the green rush, considering that Canada had just commenced adult-use weed sales and derivatives were presumed to hit dispensary shelves by no later than October.

Unfortunately, it’s been nothing of the sort for the pot industry. Although there have been a few cannabis stocks that have bucked the trend, the vast majority of pot stocks are down by double-digit percentages. This includes…

Aphria (NYSE:APHA), which is the 28th most-held stock on online investing app Robinhood and the fourth most popular pot stock.

As of this past Tuesday, Dec. 17, Aphria’s share price had fallen 14% in 2019, which actually means it’s outperformed most of its Canadian cannabis-growing peers. Nevertheless, a double-digit decline isn’t what investors signed up for at the beginning of the year, especially with marijuana sales expected to take off in Canada.

But given this decline, the question has to be asked: Is Aphria now a decent value that investors should buy? Before answering, let’s take a closer look at the buy and avoid thesis on Aphria; then we’ll circle back and tackle the question at hand.

The buy thesis

On the buy side of the equation, perhaps the biggest selling point for Aphria is the revenue predictability that the company can bring to the table. Although most folks think of Aphria as purely a marijuana grower, it can’t be overlooked that the company acquired pharmaceutical distribution business CC Pharma in January 2019.

Despite pharmaceutical distribution being a relatively low-margin operating segment, it’s on track to generate in the neighborhood of 375 million Canadian dollars in revenue for the current fiscal year, if not a bit more. Demand for pharmaceutical products tends to be pretty steady, meaning Aphria’s top line is considerably more predictable than its peers.

To add to this point, Aphria’s first-quarter operating results for fiscal 2020 featured an 8% increase in adult-use weed sales to CA$20 million, with an adjusted gross margin of almost 50%. Most pot growers have been contending with a modest decline in weed sales in recent quarters, so this proved to be a nice surprise for investors and demonstrated that the company clearly has a number of lucrative supply deals in place.

Aphria’s production potential is also noteworthy. While operating only three cultivation farms, Aphria’s peak capacity of 255,000 kilos per year would make it possibly the third-largest grower in Canada. Having two of its three grow farms top the 100,000 kilo-per-year peak production mark should allow Aphria to utilize economies of scale to push its per-gram growing costs below the industry average.

Lastly, this is a company that’s sitting on a healthy amount of liquidity at a time when funding has once again become a concern. Aphria ended Q1 2020 with cash, cash equivalents, and marketable securities of CA$464.3 million, which should be more than enough to fund international expansion opportunities — Aphria has access to nearly a dozen countries, primarily from stemming from its Nuuvera acquisition — as well as broaden its high-margin derivative product portfolio.

Sounds like a slam-dunk buy, right? Well, not so fast.

The avoid thesis

On the other side of the aisle, Aphria (and the entire Canadian weed industry) is going to have to contend with persistent supply issues throughout Canada. Regulatory agency Health Canada has struggled to review and approve licensing applications in a timely manner, and Ontario, the country’s most populous province, had just two dozen open dispensaries on the one-year anniversary of the commencement of recreational sales. In fact, the flagship Aphria Diamond joint venture took between 18 and 21 months to be approved for cultivation from Health Canada.

These factors, while fixable, are going to take regulatory agencies numerous quarters, if not years, to resolve, thereby allowing the black market to thrive. This means Aphria’s production advantage isn’t as meaningful as investors might think.

Next, it’s important for investors to realize that Aphria’s quarterly profits have all come with asterisks. You see, International Financial Reporting Standards for Canadian stocks require growers like Aphria to estimate the value of their crops each quarter, as well as their projected cost to sell these goods. This has resulted in positive fair-value adjustments that fail to capture how the business is really performing. If these one-time costs and benefits are stripped out of the equation, we’d see a company that’s still losing money on an operating basis — specifically with regard to its cannabis operations.

third issue to consider is investor trust. At this time last year, Aphria was contending with…

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