Despite some early-stage growing pains in Canada, you’d have a hard time finding a better-performing industry in 2019 than marijuana. Since the year began, the Horizons Marijuana Life Sciences ETF, the very first tradable cannabis exchange-traded fund, has risen by 42%, which is more than triple the return of the broad-based S&P 500 of nearly 13%, through this past weekend.
The bullishness surrounding pot stocks primarily has to do with their long-term sales potential. It’s no secret that the cannabis black market is generating tens of billions of dollars in annual sales worldwide, so moving even a portion of those sales into legal channels can have a big impact on marijuana stocks and legalized countries.
However, not every pot stock has participated in the 2019 rally or kept pace with their peers. For some Wall Street investment firms, a few of these beaten-down marijuana stocks look like potential bargains, as evidenced by covering initiations and rating reiterations this past week.
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On Friday, Jefferies analyst Owen Bennett initiated coverage on Aphria (NYSE:APHA) with a buy rating and a price target of 15 Canadian dollars ($11.16). Based on the previous day’s close, Jefferies foresees up to 74% upside in Aphria’s share price. Said Bennett in a note to investors:
On our strategic scorecard Aphria scores highly, and third overall behind only Canopy [Growth] and Aurora [Cannabis]. Despite its strong global outlook, its valuation is the cheapest across our space, with allegations around inflated assets/insider deals weighing.
With these issues now seemingly cleared up, as the company continues to execute, and with likely positive developments on US optionality/Canadian derivatives, we see significant rerating.
The big surprise here is that Aphria, while fundamentally inexpensive, has been a complete mess at the managerial level.
In early December, it was rocked by a short-seller report from Quintessential Capital Management and forensics analysis firm Hindenburg Research, which claimed Aphria had grossly overpaid for Latin American assets that had been purchased by SOL Global investments (the company Aphria purchased these assets from) for mere pennies on the dollar. An independent committee investigated these claims and determined that Aphria had paid a price that was within reason for these assets. However, the committee did uncover that there were conflicts of interests with related parties in this transaction, ultimately leading to a handful of executives, including longtime CEO Vic Neufeld, stepping down.
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Not long after, Aphria would report its fiscal third-quarter results and take a CA$50 million chargeagainst the carrying value of its CA$195 million Latin American asset purchase. Despite the committee finding that the price paid was reasonable, a request from the Ontario Securities Commission led to the pretty sizable writedown.
Furthermore, this wasn’t the first transaction that was called into question for Aphria. The day prior to closing its acquisition of Nuuvera in March 2018, investors learned that a number of Aphria executives held stock positions in Nuuvera. While it’s not unheard of for executives of one company to hold an equity stake in the company they’re acquiring, it’s something that investors would have liked to know well in advance of the deal closing, rather than the day prior.
Owen Bennett and Jefferies may see the smoke clearing, but I, personally, have little faith in Aphria’s management team. It’s going to take plenty of action on the company’s part to change my mind, and likely the minds of many other marijuana stock investors.
This past Friday also saw analyst Bobby Burleson at Canaccord Genuity reiterate his firm’s speculative buy rating and $7.50 target on ancillary cannabis player KushCo Holdings(NASDAQOTH:KSHB). Based on the previous day’s close, this represents potential upside of 62%.
Having initiated KushCo as a speculative buy roughly six months ago, Burleson opined in a note not long thereafter that KushCo had the lowest execution risk of the half-dozen marijuana stocks Canaccord Genuity was covering at the time.
But should KushCo, which is actually down about 12% year to date, be considered for purchase by investors? As someone who recently opened a position in KushCo within the past few weeks, it’s an analyst reiteration I can certainly get behind.
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KushCo should be able to firmly plant itself in three core niches within the cannabis space. First, it’s a compliant packaging and branding solutions specialist with over 5,000 global cannabis clients. Selling medical and/or recreational weed means having to comply with packaging that’s child- and tamper-resistant and adhering to federal, state, and/or local laws. KushCo is in charge of handling these logistics, as well as ensuring that branding and packaging design helps pot companies stand out in an increasingly crowded field.
Secondly, KushCo stands to benefit as the industry promotes derivative products (i.e., anything other consumption by smoking dried flower). The company sells and supplies a variety of vaporizer components and heating elements, all of which should be legal in Canada by mid-October, at the latest. A new generation of marijuana users have demonstrated that derivatives are the future of the cannabis industry, putting KushCo’s vape products in the middle of a rapidly growing segment. As one added note, the company also recently announced that it would be passing along higher tariff costs to consumers, thereby minimizing the margin pressure that KushCo has recently dealt with on its vape products.
Third and finally, KushCo’s acquisition of Summit Innovations in 2018 makes it a key player as a supplier of hydrocarbon gases and solvents in the cannabis space. The former is used in the production of cannabis oils, with the latter critical for concentrate production. Again, with derivative use gaining steam, KushCo finds itself in all the right ancillary spaces as the pot industry ramps up.
With a genuinely low price-to-sales ratio, KushCo looks like a far better bargain than Aphria.
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