Menu

Aphria Stock Could Be the Best Play for Cannabis Contrarians

There are two broad bull cases that would drive an investor to try and time the bottom in a cannabis name like Aphria (NYSE:APHA) stock. The first is to question the months-long plunge in the sector and in Aphria stock. Investors erroneously are reacting to short-term challenges and ignoring the long-term opportunity.

The second case is that the declines this year actually make some sense — but at this point, cannabis stocks simply are too cheap.

From this perspective, investors were wrong in March, when the sector was trading at the highs. What’s clearly become a massive oversupply problem in Canada isn’t a transitory issue. Rather, cannabis production is, and will be, largely a low-margin, commoditized business. Yet for certain stocks, even that issue is priced in, or close.

Aphria stock might not be the perfect stock from either viewpoint. But it can fit both arguments — which makes it among the most attractive stocks for investors looking to buy the cannabis dip.

Aphria Stock and Oversupply

There is a case that pot stock investors are being short-sighted at the moment. Certainly, oversupply problems are real. Many producers in the industry are receiving lower prices for their cannabis.

In its most recent earnings release, Cronos (NASDAQ:CRON) reported a 28% decline in selling price quarter-over-quarter. Tilray (NASDAQ:TLRY) saw similar pressure. Canopy Growth (NYSE:CGC) announced price cuts on softgels and oils.

But that oversupply shouldn’t be a surprise. The Canadian retail market is a mess. Regulator Health Canada is “overwhelmed,” as one former inspector put it. Applications have been slow to process. Required amendments take months to be approved. The rollout of retail stores has been slowed. Launches of “Cannabis 2.0” products like edibles and vapes will slip into 2020.

From this perspective, of course the market is oversupplied. Demand is being artificially suppressed by too few retail stores with too few derivative products.

This is broadly the case that Aphria CEO Irwin Simon made on a recent podcast. He told his interviewer that Aphria was headed for production capability of 265,000 kilograms.

“I could sell 265,000 kilos of product, in my opinion, today if I had the ability to grow that [amount],” he said.

Simon pointed to the lack of stores in Ontario, Canada’s most populous province. And he noted the ability to sell in Europe and South America.

Is APHA Stock the Play?

If Simon is right, or close, Aphria stock has real upside. As I detailed last month, it’s far and away the cheapest of the major cannabis producers. Its balance sheet is in better shape than the likes of Aurora Cannabis (NYSE:ACB) or Hexo (NYSE:HEXO): cash on the balance sheet is roughly equivalent to total debt.

Meanwhile, Aphria itself hasn’t yet seen the same pricing pressure as other rivals. Adult-use pricing actually increased in the company’s most recent quarter versus the prior period.

It remains to be seen whether that holds as the company doubles production under a new cultivation license. But the company already is profitable on an Adjusted EBITDA basis. Even assuming pricing does come down, costs will moderate as well.

In other words, Aphria can muddle through an oversupplied market. Canada’s retail infrastructure will get built out. International markets can soak up excess product. Profitability at the least should hold.

To be sure, investors might look elsewhere. Aurora Cannabis stock, for instance, remains the highest-risk and highest-reward stock in the space. Canopy Growth still has an impressive cash hoard. From a “go big or go home” perspective, Aphria stock might not be the play.

Still, there’s a solid case here. Aphria is profitable (if on an adjusted basis). New management minimizes concerns about past decisions. Aphria’s production capability matches that of most rivals. If the sector is going to bounce back, APHA stock no doubt will do the same.

A New Normal

That said, I’m not sold on the idea that oversupply is a transitory problem. Farming any plant generally is a commoditized business. Admittedly, cannabis has myriad strains and multiple delivery mechanisms, but in any type of agricultural business, it’s processors, not producers that make the profit.

From that perspective, Cronos stock might be the more interesting play. It’s following the playbook of its key investor, looking to buy third-party production rather than investing capital to develop its own supply. That’s done little for CRON stock so far, but that company looks best-positioned for an oversupplied environment.

That said, Aphria can at least survive in such a scenario. The tangible book value is about $3.25 per share. Aphria still has CAD$464 million in cash that could go to buy distressed assets. And Simon has called out the huge opportunity in South America as well.

Even at the lows, APHA stock isn’t quite compelling. I’d be cautious about buying any cannabis stock at the moment given consistent pressure on the sector. But given the steep decline in Aphria stock, other investors admittedly can see the sector quite differently.

And Aphria stock still looks like one of the best choices for those investors. In fact, it might be the best choice. There’s a lot to like here. And there’s a case that more investors will see that once the clouds over the industry finally dissipate.