From a performance standpoint, Aphria (NYSE:APHA) continues to be an outlier in the cannabis space, but Aphria stock is held down by the overall sector.
While peers struggle to drive profits, Aphria already has delivered on that front, posting positive Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) in each of the last two quarters. Guidance for fiscal 2020 (ending May) suggests the company should post positive net income for the full year.
That profitability is in noted contrast to peers like Canopy Growth (NYSE:CGC), for which even EBITDA profitability likely doesn’t arrive until 2021 at the earliest. And Aphria has moved toward profitability without selling billions of dollars in shares, as both Canopy and Cronos Group (NASDAQ:CRON) have done.
Nor has Aphria leveraged its balance sheet. While the likes of Aurora Cannabis (NYSE:ACB) and Hexo (NYSE:HEXO) face significant debt challenges, Aphria’s cash at the end of the first quarter was nearly equivalent to its total borrowings. The combination of a solid balance sheet and profitability is one simply not found among cannabis stocks right now.
Yet Aphria stock hasn’t been much of an outlier in terms of trading. Admittedly, relative to its 52-week high, APHA stock has outperformed many other cannabis names. CGC shares, for instance, are down 63% from late April peaks. ACB stock is off 80%. In contrast, Aphria stock has declined “only” 50%.
Of course, that’s obviously still a steep haircut. And Aphria’s far stronger performance as a business suggests that APHA should have posted much better performance as a stock. With shares seemingly finding a bottom around $5 in recent weeks, it’s worth considering whether that performance is starting to arrive — and what can send Aphria stock even lower from here.
Is Aphria Stock Really Cheap?
In its first-quarter earnings release in October, Aphria reaffirmed full-year guidance for CAD$650 to CAD$700 million in revenue and Adjusted EBITDA of CAD$88 to CAD$95 million. That release was enough to send Aphria soaring over 24%. Within a month, however, continued pressure on cannabis stocks erased all of those gains, and then some.
After another rally, Aphria (based on its price on the Toronto Stock Exchange) has a market capitalization of CAD$1.655 billion. Add in net debt of roughly CAD$18 million and its enterprise value sits at about CAD$1.67 billion.
Those figures suggest that APHA stock is rather cheap. EV/revenue, even at the low end of guidance, is below 3x. EV/EBITDA, again at the low end, is 19x.
CGC stock trades at over 7x estimated fiscal 2020 revenue. ACB is valued at over 9 times sales. And, again, there isn’t a cannabis peer with even positive EBITDA in fiscal 2020, barring a huge surprise.
At least based on FY20 numbers, APHA stock far and away is the cheapest stock in the sector. And what’s interesting at this point is that Aphria stock really isn’t that expensive relative to the market as a whole. The S&P 500 has an EV/revenue multiple in the range of 2.5x. EV/EBITDA is near 14x.
To be sure, these metrics alone don’t guarantee that Aphria is too cheap, or even necessarily cheap. Other cannabis companies may (and likely will) post stronger growth after fiscal 2020, and the market is incorporating that growth to some extent. EV/EBITDA multiples are imperfect, and better used for comparisons than absolute valuation. On a P/E basis, Aphria looks a bit more expensive (though even a ~16x multiple to fiscal 2022 estimates looks rather attractive).
What Goes Wrong for APHA Stock
Still, the broad point holds. Aphria has a reasonable valuation on an absolute basis, and an enormously attractive valuation on a relative basis. Considering the relatively safe balance sheet, that combination would seem to suggest that current trading around $5 makes sense. APHA has stabilized because it is simply “too cheap”.
What changes that thesis? The most obvious potential culprit is the company’s guidance. Aphria is projecting a significant increase in profitability in 2020. Adjusted EBITDA for fiscal 2019, even with a profitable fourth quarter, was negative $27 million. The Q1 figure was barely $1 million. Aphria needs to turn on the proverbial jets over the next three quarters to match its outlook.
That’s far from guaranteed. As Brad Moon detailed this week, we still don’t know how the launch of “Cannabis 2.0” products will perform, despite broad-based optimism in the industry. That launch aside, the sector’s history adds another concern. Cannabis companies have established an unfortunate track record of overpromising and underdelivering. Some investors no doubt see a similar risk with Aphria.
The other concern centers on valuation multiples. It’s possible that cannabis simply isn’t a good business, particularly on the production side. Margins for growers may well see a “race to the bottom”. Consumer products, whether flower or derivatives like vapes and oils, will see intense competition, and potential pricing pressure as well.
If the industry doesn’t grow as bulls hope, and/or margins are much lower than projected, cannabis stocks on the whole aren’t that attractive. In that scenario, 2019 trading could repeat going forward. Aphria stock probably outperforms the likes of ACB and HEXO — but still declines further as its multiples compress.
The Case for Aphria Stock
From this perspective, however, the broad case for Aphria still holds. As I’ve written before, investors hugely bullish on cannabis probably should look elsewhere. The same balance sheet leverage that has led ACB and HEXO to underperform would have a reverse impact if and when the sector rallies. Canopy Growth likely will have a larger and broader reach.
If an investor’s thesis is that the 2019 sell-off in cannabis names is wrong — that the market is being short-sighted amid regulatory delays and disappointing early results — APHA stock isn’t the pick. But if an investor believes that a healthy correction has occurred, that’s where Aphria stock gets interesting.
The case here is that the industry isn’t going to be quite the performer bulls believed when cannabis stocks soared in 2018. But it’s still a good business. It’s a business that can drive enough growth to buy a stock valued only at a modest premium to the mature, low-growth names in the S&P 500.
Of course, those investors also have to trust Aphria management, given the apparent early risks to guidance. With a new CEO on board after questionable decisions by past executives, that’s easier to do.
And so I still believe, as I’ve written before, that APHA stock is the best play in cannabis. But that doesn’t mean it’s a risk-free trade. Both Aphria and the industry have to deliver for currently stable trading to hold. I’m personally not quite convinced enough on both points to put money behind Aphria stock. But other investors can, and do, see it differently.
As of this writing, Vince Martin has no positions in any securities mentioned.
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