Back in December, I wrote that to value Aphria (TSX:APHA)(NYSE:APHA), one must discount its questionable Latin American assets all together and to focus only on its domestic growth potential. Based on this analysis, I estimated that the stock presented 50% upside from its then mid-$5 range. Even with all overhang from the short-seller report, Aphria presented a tremendous buying opportunity.
Now that six months have passed since my original estimate of $7.50/ share, it’s time to revisit Aphria to see if there is still room for growth with this controversial name.
Not a $21 stock
Firstly, let’s just rip the band-aid off: Aphria is not going to return its +$20 highs any time soon. The +$5 billion market cap Aphria commanded when it was trading north of $20 was based solely on sector-wide euphoria and growth prospects that had little chance of ever materializing. More importantly, the all-time-high market cap was a feature of a controversy-free company that seemingly had a strong international presence and roughly third- or fourth-place market share in the Canadian market.
Now, six months later, we begin to see that Aphria was hardly a well-run company, and the international footprint was much smaller than anticipated. For example, those apparently valuable Latin American assets have experienced a write-down of $50 million (representing roughly a fifth of their value), despite management’s earlier assurances of their fiscal due diligence. And while the case can be made that the write-down was a non-cash charge, the fact remains that shares were issued for those assets and the dilution stays on the books, regardless of accounting policies.
Furthermore, in stark contrast to its major-league peers, the company has withdrawn its plans to pursue the U.S. market, which could lead it to trail its competitors once we see federal legalization south of the border.
However, to give credit where it’s due, Aphria is continuing with its expansion plans in Europe, having won five out of 13 cultivation lots for medical marijuana in the nascent German market. That said, the European market is still in its infant stage, and forecasts of European sales should be relatively conservative at this point.
Aphria’s latest earnings also pointed to an increasingly competitive Canadian market. In Q3 of this year, Aphria sold 23% less product than in the previous quarter, while all-in costs of sales adjusted for packing and distribution increased 60%. Moreover, while many were predicting Q3 medical sales to come in below Q2, as recreational sales ramp up and cannibalize the medical sector, the last quarter also saw recreational sales decline, along with the average selling price in the adult-use segment falling to $5.14/ gram from $6.32/gram.
What is Aphria worth?
To value this company, once again we must discount its Latin American businesses entirely and focus solely on its domestic and European operations. Using analyst estimates of a $5 billion Canadian market in 2021 and a 15% market share, I predict Aphria’s 2021 domestic sales will come in at roughly $750 million, or $800 million when combined with sales from its European subsidiaries.
Based on a 28$ EBITDA margin and 14 times forward multiple (a discount to its large-cap peers, owing to lack of U.S. penetration, and management risks), we can assume the share price to be worth roughly $12.50 per diluted share. Applying a 10% discount to the fair value to compensate for sector volatility and execution risks (AKA loss of shareholder confidence), we arrive at a $11.25 price, or 25% upside from current levels. In other words, Aphria is a buy at these levels, as long as you are not anticipating a two- or three-fold increase in its share price any time soon.
