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You Should Sell This Popular Pot Stock, According to One Wall Street Firm

Sean Williams, The Motley Fool

Although there are a lot of industries expected to deliver big-time growth over the next decade, cannabis might be the kingpin of them all. The industry generated nearly $11 billion in global marijuana sales in 2018, and various Wall Street forecasts are calling for between $50 billion and $200 billion in full-year sales by 2029/2030. No matter how you cut it, the worldwide legal cannabis annual growth rate is expected to be in the double digits.

Much of this optimism is reflected in the ratings and price targets that Wall Street has bestowed on pot stocks. It's commonplace for the equivalent of buy and hold ratings to handily outnumber sell ratings on Wall Street, and this practice has certainly been carried over to the cannabis industry.

However, even Wall Street knows that not every company in the fast-paced pot industry can be a winner. Last week, one of the more high-profile cannabis stocks was downgraded to the equivalent of a sell.

A businessman in a suit pressing the sell button on a digital screen.

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Embattled cannabis stock Aphria earns a "doobie-ous" rating

On Friday, July 26, analyst John Zamparo at investment bank CIBC downgraded embattled marijuana stock Aphria (NYSE: APHA) from neutral to underperform (the equivalent of sell), and cut his firm's price target nearly in half, from 12 Canadian dollars ($9.11 U.S.) to CA$6.50 ($4.94). Based on Aphria's U.S. close of $5.84 the day prior to the downgrade, Zamparo is looking for about 15% additional downside in Aphria's share price.

If you're wondering why Zamparo has had a change of heart on Aphria, he boiled it down to three reasons in his note to clients.

First, consider that Aphria is currently a ship without a true captain. Longtime CEO Vic Neufeld, who headed Aphria for approximately five years, has stepped down. Without Neufeld's vision, there's clear concern that Aphria will struggle to capitalize on its numerous competitive advantages, which include international distribution and the capacity to produce up to 255,000 kilos of cannabis a year when fully operational.

Secondly, Zamparo sounded a warning that Yours Truly has harped on in recent months -- namely, that Aphria is likely to take additional writedowns in the not-so-distant future. Aphria already wrote down CA$50 million of the value of its Latin American assets, and Zamparo believes an even larger writedown could await that's tied to its 2018 purchase of Nuuvera. According to Zamparo, up to CA$400 million in goodwill from this deal could be written down.

An investor holding a magnifying glass over a company's balance sheet.

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Lastly, CIBC and Zamparo foresee Aphria's fundamentals deteriorating. Previously, Zamparo had forecast CA$39 million in 2020 EBITDA (earnings before interest, taxes, depreciation, and amortization). Now he foresees just CA$4.3 million in EBITDA for 2020, with a sizable loss in 2019. He also reduced his 2021 sales forecast on Aphria by about 14%, although he's still expecting a more than doubling in year-over-year sales between 2020 and 2021. 

The biggest negative CIBC missed in its downgrade of Aphria

Although I have little to disagree with, based on what Zamparo wrote to clients this past Friday, his analysis of Aphria dances around one key problem: trust.

There are plenty of issues that Aphria is contending with, including supply-side problems throughout Canada, licensing holdups, and a deteriorating outlook. But this isn't unique to Aphria. Nearly every Canadian pot stock is contending with some combination of these issues.

However, what is relatively unique is the lack of trust that Aphria is facing from shareholders.

As you may know, Aphria has faced not one, but two instances where its acquisitions have been called into question. The most high profile of the two was the purchase of its Latin American assets, which were called into question via a short-seller report from Quintessential Capital Management and Hindenburg Research. Although a special committee found that the price paid for these assets was reasonable, Aphria still wound up writing down CA$50 million of the deal's value months later. To boot, the special committee also found conflicts of interest with a few Aphria insiders, which is a big reason Neufeld stepped down.

A businessman holding a neat stack of cash behind his back, with his fingers crossed.

Image source: Getty Images.

The other acquisition where investors' eyebrows were raised was the Nuuvera deal in March 2018. Just one day prior to closing, it was revealed that some Aphria insiders owned an equity stake in Nuuvera. While not unheard of for insiders to own a stake in a company they're acquiring, this is information that investors would want to know about well in advance of the deal closing to ensure that a justifiable price was paid for the asset in question.

You see, Aphria is going to have to do more than just grow 255,000 kilos of cannabis a year, as promised, and push into nearly a dozen international markets. In order for Aphria -- a company that's lost about two-thirds of its value since early September -- to really garner favor with Wall Street and investors, it's going to have to earn their trust again, and there's no timetable or concrete guideline on how to do that.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.