Bullet-Dodging Aphria Stock Is a Risky, But Rewarding Trade

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Almost nothing about the marijuana industry — legal or otherwise — is stable or predictable. Aphria (NYSE:APHA) offers further confirmation of this thesis. After going rangebound since mid-February of this year, Aphria stock dropped nearly 15% on tax day. The reason? A very poor earnings result for the fiscal third quarter of 2019.

Aphria stock provides a risky, but compelling trade

Analysts expected APHA to lose 4.5 cents CAD per share. Instead, the actual earnings per share came in at a staggering loss of 20 cents CAD. Moreover, the optics were absolutely horrible compared to the year-ago quarter, when Aphria delivered an EPS of 8 cents CAD.

This translated to a net loss of 108.2 million CAD. This also compared very unfavorable to Q3 2018’s net income of 12.94 million CAD. Therefore, it doesn’t take a rocket scientist to see why investors quickly soured on APHA stock.

Even worse for shareholders, the pain continued beyond the earnings fallout. Two days after the Q3 disclosure, Aphria stock suffered another double-digit loss. As of the time of writing, the cannabis firm is down a little over 30% from its 2019 highs in early February.

However, year to date, APHA stock has gained 25%, even with the recent volatility considered. So, can investors expect more downside, or is APHA a worthwhile contrarian opportunity?

The Dark Cloud over Aphria Stock

Late last year, Hindenburg Research made a startling accusation. In a no-holds-barred expose, the company stated that Aphria was nothing more than a “shell game with a cannabis business on the side.”

A second report later added to the credibility stain that Aphria stock incurred. Sure, marijuana firms have been on the wrong side of short-sellers before. For instance, Citron Research called out Cronos Group (NASDAQ:CRON) for deceptive business practices. But this time, the allegations were very specific and unsettling.

Most analysts got two key takeaways from the crackdown on APHA stock. First, Aphria’s management team spent more than $200 million on “largely worthless” assets. Second, the executives had a financial stake in the acquired assets.

Thus, we had a classic conflict of interest. Management worked hard to ink a deal that only benefitted them, not the shareholders of Aphria stock. At the very least, it was a violation of fiduciary duty.

An Exoneration for APHA Stock…Sort of

After months of deafening silence, Aphria’s leadership team finally responded. Actually, an independent special committee that the company’s board of directors revealed their findings. Their report was both an exoneration and condemnation of APHA stock, depending on your perspective.

First, the bad news: the committee noted that not everyone involved in the asset acquisitions were on the up and up. That sparked serious changes at the top. As our own Ian Bezek noted, former Aphria CEO Vic Neufeld stepped down, as did co-founder Cole Cacciavillani. For now, the company appointed Irwin Simon as interim CEO. Simon previously led Hain Celestial (NASDAQ:HAIN) for more than two decades.

Again, no advanced degree in rocket science is necessary to understand the negative implications. Legal marijuana is a budding (no pun intended) industry. The sector must still overcome federal restrictions. Shady dealings like this do no favors for anyone involved.

However, we do have some good news: those “worthless” assets? Turns out, they’re not so worthless after all. The investigation revealed that the prices paid were “near the top end of a reasonable price range,” as Bezek wrote. While costly, the assets provided genuine business benefits for Aphria stock.

APHA Dodges a Bullet, but You Could Ride One

Looking back at the investigation’s results, I believe the facts are net favorable to Aphria.

First, Bezek and many other analysts are correct: the cannabis industry is the Wild West of the markets. You’re going to see astounding wins in this sector. Along the way, though, most players will suffer devastating losses.

With the conflicted interests of Aphria’s leadership team, the controversy only confirmed this negative image. Yet, let’s look at this from a forward-thinking perspective. Everyone in the cannabis trade knows — if they didn’t already — that they’re being watched. To try any more shenanigans at this point is almost suicidal.

Second, Aphria stock dodged a bullet. The assets under question turned out to be genuine producers. It suggests that the company’s other dealings were also perfectly legitimate. Subsequently, revenue growth was one of the few bright spots for Q3 2019.

APHA rang up 73.6 million CAD, up substantially from the 10.3 million CAD of the year-ago level. In addition, the company’s financial statements reveal that they’re steadily moving inventory, a common concern among marijuana producers.

All in all, Aphria stock looks interesting as a speculative trade here. The bad news appears baked in, and some of it is actually good news. Of course, I’d be incredibly careful like any other cannabis play. Ultimately, though, the pros outweigh the cons.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

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