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Is Aphria a Buy?

George Budwell, The Motley Fool

Canada's third largest pot producer, Aphria (NYSE: APHA), has turned into a battleground stock this year. While the company has started to attract a few ardent supporters on Wall Street, such as investment firm Jefferies, Aphria's shares remain woefully undervalued relative to its closest peers, Aurora Cannabis (NYSE: ACB) and Canopy Growth Corporation (NYSE: CGC).

Aphria's stock is trading at around 2.2 times its 2020 projected sales, while Aurora's shares are valued at around 13.1 times next year's sales. Canopy's stock, for its part, comes in even higher at nearly 19 times the company's estimated 2020 revenue. Based on this rough comparison,  Aphria's stock comes across as way too cheap. 

Stacks of sealed glass jars containing dried marijuana buds.

Image Source: Getty Images.

Should bargain hunters take advantage of Aphria's comparatively low valuation or is this pot stock a classic value trap? Let's look at both sides of the coin to find out.

Aphria's positives

With a peak annual production capacity of 255,000 kilograms, Aphria comes in as the third-largest pot producer in Canada behind Aurora and Canopy. This top-notch production output should eventually translate into superior gross profit margins over smaller entities and allow the pot titan to quickly expand into higher-margin product categories like edibles once this market segment officially opens in Canada later this year. 

Another key advantage is Aphria's enviable position in the high-value German cannabis market. Earlier this year, the company's German subsidiary Aphria Deutschland GmbH secured a fifth cultivation license for medical marijuana in the country. That's a big deal, because Germany is widely expected to the largest cannabis market in Europe upon full legalization, and one of the biggest in the world outside North America.

Now, Aphria will have some stiff competition from other top dogs, such as Aurora, Canopy, Cronos Group, and Tilray, in this all-important European market. But the company does have a solid foothold in the continent with this cultivation license. The same can't be said for most of its lower-tier competitors. Germany should thus provide a significant boost to the company's top line in the years ahead -- despite competition from some of the industry's biggest heavyweights. 

Aphria's negatives

Aphria's lowball valuation is no accident. The company's image took a big hit late last year after some of its top brass were targeted in a short-seller report from Hindenburg Research and Quintessential Capital Management. The crux of the situation is that the report alleged that insiders benefited from the acquisition of certain Latin American assets at inflated prices.

Although an independent committee later found that the price was within a reasonable range, Aphria still took a whopping $50 million Canadian impairment charge on the acquisition in the most recent quarter. As a direct consequence, Aphria's management has being going through a major overhaul in an effort to restore investor confidence in its corporate governance. Specifically, CEO Vic Neufeld and co-founder Cole Cacciavillani have now left the company, and Aphria's soon-to-be former president, Jakob Ripshtein, also abruptly announced his resignation last month, effective June 7.

Wall Street has long taken a skeptical view toward the quality of corporate governance across this emerging space. This short-seller report -- which essentially alleged malfeasance on the part of some of Aphira's core executives -- didn't help matters. In keeping with this theme, Aphria lost a significant chunk of institutional investors following this report, which is probably a big reason the company's shares have now lost 27% of their value over the past 12 months. Unfortunately, it might take several quarters for Aphria's new management team to change this narrative. 

Another knock against Aphria is that the company doesn't have a top-tier partner like Canopy Growth or Cronos Group to help fund its expansion efforts. That doesn't mean Aphria won't be able to compete effectively, but the company is definitely at a disadvantage when it comes to expanding into other more profitable product categories, such as beverages, edibles, or pre-rolls intended for the mass market.  

Verdict

Aphria's past is problematic, but the worst of the storm seems to be over. The company remains in an excellent position to capitalize on Canada's rapidly growing cannabis market, and its promising Germany subsidiary provides a lead-in to the even more valuable European market. 

Bottom line: Aphria's dirt cheap valuation arguably isn't warranted based on how things have progressed since this short-seller report hit the street a few months ago. Bargain hunters, in kind, might want to dig deeper into this compelling growth story before the market realizes its mistake.  

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George Budwell 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.