Even With All The Risk, Aphria Inc (TSX:APHA) Presents Tremendous Upside

As you are probably aware, Aphria Inc (TSX:APHA)(NYSE:APHA) has recently been the target of a short seller report alleging that …

As you are probably aware, Aphria Inc (TSX:APHA)(NYSE:APHA) has recently been the target of a short seller report alleging that the company purchased fraudulent assets in Latin America at grossly inflated prices in order to benefit insiders at the expense of shareholders.

At the same time, while Aphria’s management has unequivocally denied the accusations, a lot of the short seller’s claims have largely gone unaddressed in an official capacity, particularly the apparent conflicts of interest between Aphria insiders and associates and the purchased Latin American companies, as well as evidence (or lack thereof) for the actual physical existence of the said companies.

Whether you believe Aphria is an innocent victim of a frivolous short attack or that it is guilty of rampant fraud, the prudent course of action if you’re looking to start a position anytime soon is to simply discount its questionable Latin American assets entirely. Fortunately for Aphria, these companies, even if they do not exist, represent a tiny fraction of Aphria’s forward earnings. So, let’s look at what Aphria does have.

First, Aphria’s Canadian operations are 100% verifiable. For example, Aphria has supply agreements with every province in Canada, such as annual commitments to Quebec, New Brunswick, Manitoba and BC for up to 12,000 kilograms, 2,500 kilograms, 2,700k kilograms and 5,000 kilograms, respectively.

Second, aside from the provinces, Aphria has supply agreements with other companies in the cannabis space, including a wholesale agreement with Emblem Corp (CVE:EMC) for 175,000 kilograms of dried flower over a five-year period.

Third, Aphria is a very low-cost producer. Aside from the last quarter, which saw a one-time logistical adjustment to its cultivation facilities, Aphria’s cash-cost per gram usually comes in around $1, or roughly 20 to 30 percent less than the peer average.

Fourth, Aphria owns the hugely successful Broken Coast suite of products. Based on a popular customer review platform, Broken Coast currently holds over 8,660 product reviews and an average 4.5 stars out of a possible 5 rating, which is far more than any of its competitors.

Given these undeniable competitive advantages, how much then should one be expected to pay for Aphria? Let’s do a quick back of the envelope projection to calendar year 2020 to find out. In two years’ time, Aphria would have finished its ramp up in domestic capacity, and should comfortably be producing 255,000 kilograms annually from its company-wide facilities.

Based on Aphria’s supply agreements, we can expect Aphria to sell at least 75% percent of its domestic total output. Using a blended selling price of $5 per gram and EBITDA margins of 30% (in line with industry estimates), we arrive at 2020 EBITDA of approximately $287 million.

Assigning an appropriate forward multiple is a bit tricky, as it would be naïve for investors to pay the same consensus 11 times 2020 EBITDA that Aphria was previously trading at given all the risk surrounding the stock. To factor in further negative shocks and potential legal overhang over the share price, we must adjust this multiple downwards.

Thankfully we can use Valeant Pharmaceuticals as a proxy. Pre-Philidor scandal, Valeant was trading at 18 times forward EBITDA, and post-Philidor, the multiple had contracted by roughly by 50%. Applying the same “scandal” contraction, we can assign a 5.5 times forward multiple to Aphria’s earnings, and adjusting for cash and debt and dividing by diluted shares, we arrive at a fair value post-scandal price of approximately $7.50 per share, or a 50% upside from Wednesday’s close.

In other words, even after discounting its Latin American operations entirely and taking into consideration all the regulatory and legal concerns surrounding the stock, the current price presents a buying opportunity, and it’s a risk worth taking.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Victoria Matsepudra has no position in any of the stocks mentioned. The Motley Fool owns shares of Bausch Health Companies.

More on Top TSX Stocks

gas station, car, and 24-hour store
Stocks for Beginners

Should You Buy Alimentation Couche-Tard Stock?

The decision to buy Alimentation Couche-Tard stock isn’t as easy as it once was. Here’s a look at the case…

Read more »

edit Woman in skates works on laptop
Stocks for Beginners

3 Defensive TSX Stocks for Lower-Risk Investors

Looking for some of the best defensive TSX stocks to buy? Here's a trio of options that will appeal to…

Read more »

Index funds
Tech Stocks

Constellation Software Stock: Buy, Sell, or Hold?

Unveiling the Code: Should you Buy, Hold, or Sell Constellation Software (TSX:CSU) stock at current levels?

Read more »

Hourglass projecting a dollar sign as shadow
Top TSX Stocks

Just Released: 5 Top Stocks to Buy in March 2024 [PREMIUM PICKS]

Forget the hype. The best opportunity is in a sector the market is ignoring.

Read more »

TFSA and coins
Top TSX Stocks

5 Canadian Stocks to Buy and Hold Forever in Your TFSA 

Are you planning your TFSA portfolio for 2024? Here are a few stocks you can buy at the dip and…

Read more »

question marks written reminders tickets
Dividend Stocks

Better Buy: Loblaw Companies or Metro Stock?

Loblaw Companies (TSX:L) stock is riding on recent momentum. Meanwhile, Metro (TSX:MRU) is executing for future earnings growth.

Read more »

Redwood trees stretch up to the sunlight.
Tech Stocks

These 3 Magnificent Stocks Keep Driving Higher

Constellation Software, Dollarama and another TSX stock have consistently generated positive investment returns. Here’s why they belong in your retirement…

Read more »

Male IT Specialist Holds Laptop and Discusses Work with Female Server Technician. They're Standing in Data Center, Rack Server Cabinet with Cloud Server Icon and Visualization
Dividend Stocks

Got $5,000? These 2 Growth Stocks Are Smart Buys

Kinaxis Inc (TSX:KXS) is a Canadian growth stock worth considering.

Read more »