Companies and Brands

Why Aphria Stock Might Be Worth Another Look

Paul Ausick

Published: February 27, 2020 10:55 am

Last Updated: February 27, 2020 10:57 am

Canadian pot grower Aphria Inc. (NYSE: APHA) did one thing right last year. The company beat back a hostile C$2.4 billion takeover attempt by Green Growth Brands. Shares of Green Growth closed at C$0.03 on February 25, just over a year from its offer to acquire Aphria.

Other than that, 2019 was a forgettable year for Ontario-based Aphria. In the first four weeks of 2019, the stock added 89%. By the end of the year, shares had lost just over 8%. As of February 25, 2020, the shares were down nearly 33% since January 2019.

The company’s troubles generally reflected the cannabis industry’s troubles last year. Pot stocks fell out of favor with investors as expected profits did not materialize. In order to effect a turnaround in 2020, several things have to happen, most of which the marijuana industry can’t control.

What Canada Needs to Do

It took the Canadian government 18 months from the time voters approved legal sales of recreational marijuana until the first retail shops opened in October 2019. The country’s regulator, Health Canada, licensed producers at a snail’s pace.

In Ontario, Canada’s most populous province, only two dozen or so retail shops were licensed and operating by the end of 2019. The province has scrapped its previous licensing scheme, which involved a lottery, and has streamlined the licensing process significantly. Aphria expects to get approval by April to open 40 more stores in Ontario.

That will help, but Aphria and other legal pot growers face stiff price competition from illegal sales of marijuana. Approximately 80% of Canada’s marijuana sales remains on the black market. Illegal pot is as much as 80% cheaper than legal pot, and the only way to shut down the black market is with more enforcement.

That’s unlikely to happen because it costs money and adds to the cost of enforcing the country’s marijuana laws in the short term. Over time, an investment in enforcement could pay off for both producers and the government. The near-term probability that Canada will spend more on enforcement approaches zero.

Health Canada also failed to license the Aphria Diamond greenhouse until November 1, a full 10 months after the company had planned to open the facility.

What About Cannabis 2.0?

Once again, Health Canada failed to move quickly enough to license derivative products like edibles, vape products, infused beverages, topicals, tinctures and concentrates. These high-margin products were not available until late last year. The sale of derivatives was expected to boost revenues and profits and to keep investors buying stock in Canada’s cannabis companies.

There were a few snags, though. For one, the province of Alberta instituted a ban on vapes following the spurt of vaping-related lung disease in the United States.

For another, sales growth has been declining at the company’s German subsidiary, CC Pharma. German government reimbursements for medical marijuana patients have been reduced.

Derivatives only began appearing on store shelves late last year. These products offer much higher margins than does cannabis flower. They also cost more to produce, and the up-front investment will only be recovered over time.

Aphria and other producers are counting heavily on growth in the derivatives part of the business as the number of licensed retail shops increases. Again, however, the government needs to move more quickly.

The United States Won’t Be Riding to the Rescue

Any illusion that the U.S. government will lift its dangerous-drug classification for marijuana in 2020 should be put to rest. The House of Representatives, controlled by Democrats, in November passed out of committee a bill that would lift the so-called Schedule I status of marijuana. Yet, the full House hasn’t voted on it, and the Republican-controlled Senate is virtually certain to decline even to consider dropping the Schedule I classification.

The U.S. president has, as usual, come down solidly on both sides of the issue. When he was running for office in 2016, he favored legalizing marijuana. Last week, an official with Trump’s reelection campaign told a Las Vegas TV station that the president’s policy is to “keep our kids away from drugs,” including marijuana.

That might change if a Democrat should be elected president in November and the Democrats can win control of the Senate while keeping control of the House. The law won’t change quickly, though, and investors looking for a 2021 lifting of the ban on marijuana may be disappointed.

Aphria’s Financial Story Looks Pretty Good, All Things Considered

When Aphria released its quarterly earnings report in January, the company posted its third consecutive quarter of positive adjusted EBITDA. Not a lot of other marijuana stocks can say that.

The tardy approval of the Diamond facility forced Aphria to purchase cannabis from other licensed growers, driving up the company’s costs and trimming its margins. When the Diamond facility rolls into full operation, the company expects to produce more than 300,000 pounds of cannabis there annually. That will push yearly production to more than 850,000 pounds. Aphria owns 51% of the Diamond facility.

Aphria also received last month a C$100 million strategic investment from an unnamed institutional investor in exchange for 14 million equity units in the company.

The company’s focus on medical marijuana insulates it to some degree from the hurly-burly of recreational retail. In its latest earnings report, Aphria said its average retail selling price for medical marijuana was $8.16 per gram. The company’s average for recreational cannabis sales was $5.22 per gram. Canadian insurers may pay up to $6,000 annually for medical marijuana, a real plus for Aphria, but not especially a growth market.

Analysts remain bullish on Aphria. Since the beginning of the year, two firms have either initiated or reiterated Buy ratings on the stock, and two others have Neutral ratings. In the current quarter, which ends in February, analysts are forecasting a net loss per share of C$0.03 on revenues of C$131.58 million. For the May quarter, analysts see earnings of a penny a share on sales of $159.47 million.