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With 2018 now in the books, investors can look back and confidently proclaim it to be the “Year of Cannabis.” At no time in the history of the marijuana industry have such significant advancements been made. As you can imagine, the legalization of recreational marijuana in Canada tops the list. No single action validated the weed industry as a legitimate business model more than the first industrialized country in the world giving pot the green light in October.
But there was so much more than this that occurred last year. We saw a handful of U.S. states and foreign countries wave the green flag on cannabis in some capacity, witnessed the U.S. Food and Drug Administration approve its first cannabis-derived drug, and saw President Trump sign the Farm Bill into law in late December. The Farm Bill legalized hemp and hemp-based cannabidiol (CBD) — CBD is the nonpsychoactive cannabinoid best known for its perceived medical benefits.
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Should pot stock Aphria be on your buy list this year?
On the other hand, marijuana stocks didn’t fare as well. After two very strong years for pot stocks, many prominent names delivered double-digit percentage losses for investors in 2018. Among the worst performers was Canadian cannabis grower Aphria (NYSE: APHA), which shed 61% last year. Considering how quickly the pot industry is growing and countries are legalizing, the big question to ask is this: Should you buy Aphria as a rebound candidate in 2019 or leave it be?
Let’s take a look at both sides of the argument.
Aphria could bounce back in a big way in 2019
Possibly the biggest reason for investors to be excited about Aphria’s prospects this year is the proposed hostile takeover bid from Green Growth Brands, which completed a reverse takeover of Xanthic Biopharma a few months prior in order to become a public company. The offer from Green Growth Brands values Aphria at approximately $2.1 billion, and was a nearly 46% premium to where the company had closed on the Toronto Stock Exchange on Dec. 24.
According to the most recent press release from Green Growth Brands, Aphria’s shareholders would retain about 60% ownership in the combined entity, with Green Growth shareholders owning 34% and the remaining 6% going to subscribers responsible for 300 million Canadian dollars in financing. Even though Green Growth is under no obligation to move forward with its hostile bid following discussions with Aphria’s management team, this loose proposal does provide hope that Aphria is worth significantly more than what it’s currently being valued at.
Secondly, there’s the potential for Aphria to land a brand-name partner in 2019. Last year we saw Molson Coors Brewing Co. form a joint venture with HEXO; alcohol giant Constellation Brands took a $4 billion equity investment in Canopy Growth; tobacco behemoth Altria made a $1.8 billion equity investment in Cronos Group; and Anheuser-Busch InBev formed a joint venture with Tilray. Beverage, tobacco, and pharmaceutical industries with challenged sales are looking for a means to supercharge their top- and bottom-line growth, and partnering with cannabis stocks could be the answer.
Of note, Aphria added Tom Looney to its board of directors in the latter half of 2018. Looney had previously spent more than 30 years in the alcohol beverage industry, including time as the former president of Diageo‘s U.S. Spirits & Canada division. Diageo has made no secret about its interest in seeking out a cannabis partnership to develop infused beverages, and the hiring of Looney could be the link that allows a deal to come to fruition.
And third, if Aphria can meet its previously forecast production figures, it’ll slot in as the third-largest producer in Canada with 255,000 kilograms at peak capacity. Aphria has done a good job of focusing on higher-margin alternative products, such as cannabis oils, in the early going, and is currently constructing an extraction facility that should be capable of 25,000 kilogram-equivalents of concentrates per year when fully operational.
In other words, there’s a lot of excitement surrounding Aphria and its much-reduced $1.5 billion market cap.
It’s damaged goods with far too much uncertainty
On the other hand, there’s also a lot for investors to worry about in the year to come.
Arguably the biggest concern for Aphria is regaining the trust of Wall Street and investors that’s been lost following damaging allegations from sell-side firm Quintessential Capital Management. In early December, Quintessential and forensic analysis firm Hindenburg Research coauthored a report claiming that Aphria had acquired three Latin American assets from SOL Global Investments for CA$300 million that were, in fact, “worthless.” The report alleged that these properties had been purchased by shell companies for much less, and that an Aphria advisor was directly benefiting from the overinflated acquisition.
For its part, Aphria has vehemently denied such claims and released a handful of press releases that back the logic of its Latin American purchases. It claims to have also received a fairness opinion and financial advice prior to commencing its share-based bid for SOL Global’s assets. Even if Aphria can prove these allegations completely false, it’s going to take time for the company to regain investors’ trust.
To boot, this wasn’t the first time in 2018 that an Aphria acquisition came into question. Its purchase of Nuuvera, which closed in March, came under fire after it was disclosed just one day prior to closing that Aphria insiders had an ownership stake in Nuuvera. While not completely unheard of for insiders at one company to have a vested stake in the company they’re acquiring, investors would want to know about it more than a day in advance.
Another concern is that Aphria isn’t generating an operating profit as of yet. The legalization of recreational weed in Canada may have been groundbreaking, but it completely transformed the way investors analyze pot stocks. No longer are simple promises enough to send marijuana stocks higher. Operating results actually matter — and in the case of most marijuana stocks, they’re losing a lot of money on an operating basis. Aphria’s need to complete its capacity expansion projects, market its recreational brands, expand into new markets, and make acquisitions are all reasons expenditures should outweigh revenue in 2019.
So, what’s an investor to do?
Based on sheer production potential, Aphria’s valuation is very tough to beat. The only producer that appears to offer better value for peak production is OrganiGram Holdings, with a market cap of around $500 million and 113,000 kilograms of peak forecasted output. Aphria’s 255,000 kilograms would make it an attractive company for brand-name partners, and could be critical in helping it to secure long-term supply deals.
But the fact remains that Wall Street and investors simply don’t trust Aphria and its management team after what could be a second questionable acquisition in 2018. Trust is very difficult to regain, and there’s no timetable on how long it could be before investors stand behind this management team once again. For that reason, I’d suggest leaving Aphria on the sidelines in 2019 and focusing your efforts on marijuana stocks with brighter prospects and far fewer adverse overhangs.
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of Molson Coors Brewing. The Motley Fool recommends Anheuser-Busch InBev NV, Constellation Brands, Diageo, Hexo, and OrganiGram Holdings. The Motley Fool has a disclosure policy.