For two quarters in a row, Canadian medical marijuana stock Aphria (APHA) did something unusual for a cannabis stock: It earned profits.
In the first and second quarters of 2019, Aphria reported quarterly net income of $16 million and $41 million, respectively. But mounting "general and administrative" spending, combined with higher share-based compensation expenses, marketing costs, R&D, amortization and a large one time charge to earnings for asset impairment, wrecked this unusual story in Q3 last month, pushing Aphria stock into an $82 million loss for the quarter.
Aphria stock plummeted on news of the loss -- no huge surprise there. But on Friday Aphria recovered a good chunk of its losses, and for this, shareholders can thank the friendly analyst at Jefferies, who initiated the stock with a 'buy' rating and $200 price target, and declared Aphria to be the cheapest cannabis stock on the market today.
"Despite a strong global positioning, Aphria's valuation is the cheapest across our coverage names," asserts Jefferies' Owen Bennett, with Aphria stock selling for an enterprise value of 2.4 times projected fiscal 2020 sales, versus average valuations closer to 13x 2020 sales prevalent among other large marijuana producers.
Incidentally, if you're wondering why Jefferies chooses to phrase its valuations in terms of multiples to sales, rather than to earnings, the analyst explains: "When comparing valuations, looking at EPS right now is pretty pointless [because] there are a number of entries ... that are almost impossible to model year over year and therefore accuracy will likely be limited."
Of course, the question remains: However you choose to value it, why is Aphria stock so cheap? Well, the lack of profits -- caused by the big Q3 writedown -- is one obvious explanation. In Bennett's view, however, the more serious concern regarding Aphria of late has been that "a short seller [has been] making allegations of [Aphria] falsely inflating assets and [engaging in] insider dealing," frightening investors away. Bennett, however, defends the company, arguing that "questionable relationships have [since] been severed and a special committee review found assets had not been falsely inflated," which the analyst believes have "cleared up" this issue.
As a result, Bennett believes that these "headwinds" should now abate, allowing Aphria's valuation to rise as investors begin to refocus on Aphria's "strong" global positioning. Here, the analyst refers in particular to Aphria's "strong existing Canadian medical business," "access to attractive medical IP," its "well segmented branding approach" to selling recreational marijuana, and "access to capital to fund growth" in the wake of recent debt offerings ($350 million raised through a sale of convertible senior notes in April). Bennett further praises Aphria's moves to lay the groundwork for marijuana production in Germany and Colombia, where he sees Aphria producing 30,000 kg of marijuana shortly after beginning production, and growing that output quickly to 50,000 kg per year.
Over the next several years, Bennett predicts these strengths will permit Aphria to grow its sales at a compound annual rate in excess of 100%, yielding sales of C$1.3 billion by 2023 ($1 billion US) at a 24% EBITDA margin.
Granted, EBITDA isn't the same as actual GAAP profits. But if you accept Bennett's argument that profits are "pointless," and that sales growth alone is the proper way to value marijuana companies, then it gets a little easier to understand the analyst's eagerness to recommend a company that earns no profits -- yet is valued in excess of $1.6 billion regardless.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.
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