Is Aphria Really Any Worse off Than Other Cannabis Producers?
Growing cannabis, marijuana in greenhouse
Negative sentiment with Aphria
Aphria (APHQF) has had to endure a lot of negative press so far in 2018, with its share price taking a big hit as a result. A lot of that has been attributed to the Nuuvera acquisition, although I think there is more to it than that.
With the general cannabis market considered to be overvalued at this time, it's worth taking a look at why Aphria has been sold off more than its peers so far in 2018.
In this article we'll look at whether or not the market has overly punished Aphria in regard to Nuuvera, and what the implications are for the broader cannabis market on the production side of the business.
The biggest concern aired concerning the acquisition of Nuuvera by Aphria was the price tag itself, which was C$826.0 million. Most of that response came from the idea the company being little known by the market.
Although I see no relevancy to this alleged issue, there were reports on the fact executives at Aphria has taken a position in Nuuvera without publicly disclosing that information, implying it was a shady deal and other such things, even though there is absolutely no legal requirement to make the disclosure.
On the first issue, it's really an odd thing to conclude in regard to the notoriety of a company being the determining factor in its value. It makes no sense really.
Take Warren Buffett. We've seen him make a number of acquisitions or taking of big positions in companies that cause a lot of investors to scratch their heads through the years. Just because the overall market doesn't see the value doesn't mean it doesn't exist. Or if it's off the radar of investors doesn't imply it doesn't have value.
As for the public disclosure non-issue, I don't even see why it has been included in the conversation. About the only thing that can be observed there is the marijuana industry, because of it continuing to be illegal in many countries, generates a negative outlook on the sector to some. So any type of behavior that may even suggest impropriety can disproportionately impact a company. Even that's stretching it in my view. After all, lots of investors have had positions in a company before making an offer for the entire firm.
I belabor this a little bit to point out what I think the real issue is with Aphria. How I see it is the cannabis industry is probably overvalued. So when any type of negative press is applied to a particular company, the market can over respond and drive the share price down, as the shorts take over. That's without a doubt what has happened with Aprhia, as it really isn't doing anything different than its peers are doing.
They have diluted their shares as well while looking for ways to scale while lowering costs.
What I'm saying is the market is skittish, and any meaningful negative news is going to have a significant impact on the share price of any pot producers leading up to the legalization of recreational pot in Canada.
Other factors with Nuuvera
A couple of other key things to consider with the Nuuvera is first, the acquisition is primarily a play on international growth. Since the market is rewarding companies because of the upcoming legalization in Canada, companies aren't going to be rewarded in the short term for actions they take that will support their performances in the long term.
That may seem counter-intuitive, but cannabis producers are attracting mostly speculators and traders at this time, and they're looking for things that drive the stocks in the short term. This is a major reason I see Aphria not only not being rewarded, but also why it has been punished for the acquisition. I see that probably changing over the long haul, but that won't happen until the market settles down after legalization and more clarity on whether or not the companies are able to produce at guided levels. In other words, will additional capacity come on line within the time frame asserted by a number of companies.
One key element I don't think the market in general has taken notice of concerning Nuuvera, is its laboratory that includes a Good Manufacturing Practice (GMP) certification.
Over the long term branding is going to play a part in differentiation, and having the certification in place and the accompanying quality strains, it could be a solid foundation for branding different strains and carving out a defendable moat; this would help in the domestic and international markets over time.
Outside of Nuuvera, another negative catalyst was when the market discovered the proposed supply agreement with Shoppers Drug Mart won't be the exclusive one originally thought, so it doesn't represent a competitive advantage for Aphria.
Aphria reflects the fragility of the cannabis market
The most important thing about the performance of Aphria so far in 2018 is that the market is very susceptible to rapidly turning negative on any news that appears to be substantial.
Even though there really wasn't anything different with Aphria when measured against similar actions by its peers, it has been pummeled because of the negative news headlines.
This to me implies the market does consider cannabis producers as being overvalued, or at minimum, susceptible to getting hammered if anything disrupts the positive narrative and momentum. That means at best, the market sees cannabis producers at the top end of their value, and anything interfering with that requires an immediate reassessment of the short- and long-term outlooks of the companies.
To put it another way, to justify the high multiples and valuations, almost nothing of significance can happen to the companies that can lower their projected capacity and scalability.
As for concerns over oversupply, this is overstated in the short term, as current capacity in Canada isn't enough to supply the market once recreational cannabis is legalized. There is also the highly probable outcome of the companies not reaching guided supply levels in the near term as well.
Outside of Aurora Cannabis in regard to major producers, most of the other cannabis producers will probably welcome it taking a little longer to legalize recreational marijuana in Canada. I draw that conclusion based upon Aurora having more capacity in the near term, assuming it can complete its major facility on schedule.
Since I view Aphria as operating in a similar manner as its peers such as Canopy Growth and Aurora Cannabis, the downward pressure on its share price points to the overall fragility of the cannabis production industry; anything that gives the appearance of lowering capacity and output will result in the share price getting crushed.
Logically, Nuuvera doesn't appear to be a problem to me. It does offer long-term value to Aphria in international markets and probably in branding some of its pot strains in order to differentiate from its competitors.
The shorts of course have run with the turn in sentiment, and have made a lot of money on the opposite side of the play.
Depending on if you view Aphria as still being overvalued or not, or at a good entry point to obtain a solid position before the upcoming legalization, this is a time to take a closer look at the company.
Nothing has really changed outside of dilution because of the acquisition, but that is no different than anything its key competitors have done.
I don't see Aphria being undervalued, but its share price closer to reflecting its future potential. With others in the industry not getting hit as hard as Aphria, it appears to me it's a bargain compared to its peers.
With legalization coming and a strong gateway into the European market, Aphria is likely to rebound stronger than its peers as market sentiment turns more bullish over the next few months. It should generate some solid short-term gains.
Further out execution, cost containment and branding will take a bigger role in determining its long-term performance.