Editor's Note: A previous version of this article omitted acknowledgment of the insider trading controversy related to Aphria's Nuuvera acquisition. The article has been updated to include this information.
There are very few industries throughout North America that are growing as quickly and consistently as the legal marijuana market right now, which is a big reason why pot stocks have been privy to huge market-caps increases in recent years.
The real buzz stems from Canada, which may be just months away from seeing its red maple leaf turn green. Following a successful legalization of medicinal cannabis back in 2001, which has since been overseen by Health Canada, the country's Senate is set to vote on the Cannabis Act (bill C-45) on June 7, which if approved would legalize recreational cannabis use. Canada could become just the second country in the world (after Uruguay) to allow adult-use weed sales, and in the process generate $5 billion or more in annual revenue. Those dollar signs are hard to ignore, which is a big reason why Canadian growers have been expanding their growing capacity at a rapid pace.
A rapid transformation
Among the producers vying for a significant chunk of domestic market share is Aphria (NASDAQOTH:APHQF). Though production totals for all the top growers have been fluid as a result of strategic partnerships, supply agreements, and acquisitions, Aphria looks to be set up as Canada's third-leading supplier by annual production (about 230,000 kilograms). Depending on demand, that could be good for over 10% of domestic market share.
What's more, over this past weekend it closed the second-largest pot acquisition of all time: the roughly $670 million cash-and-stock purchase of Nuuvera. And in doing so, Aphria continued what's been a breakneck transformation over the past three months. Let me introduce you to the brand-new Aphria, following the closing of its Nuuvera deal.
Acquisitions change the face of this pot stock
Just three months ago, Aphria was all about organic expansion, which was pretty rare at the time given how quickly dealmaking was picking up in the industry. Its entire focus was on the company's four-phase, $100-million-plus, 1-million-square-foot expansion designed to yield around 100,000 kilograms a year in dried cannabis. Because it hadn't been focusing much on acquisitions, Aphria had also been one of just two big-name pot stocks (MedReleaf being the other) to report a full-year profit in each of the past two years.
However, a green flag waved over the past three months, and Aphria has come out of its shell in a big way. Within a matter of days in late January, Aphria orchestrated two of the five largest marijuana acquisitions in history. It wound up acquiring the privately held Broken Coast Cannabis for $185 million, netting the company's projected 10,500 kilograms of fully funded annual production in the process.
It also, as noted, purchased Nuuvera for $670 million. Nuuvera brings two elements to Aphria's business model that are going to be crucial for competing against the likes of Canopy Growth Corp. and Aurora Cannabis. First, it expands Aphria's international presence to 11 countries -- 12 if you count Aphria's recently signed supply agreement with Argentina, pending licensing approval. Considering the real possibility that Canada's domestic market could be oversaturated with cannabis, these international sales channels (i.e., legal overseas medical marijuana markets) are going to be crucial for offloading excess production and preserving margins.
Secondly, Nuuvera's existing product line is focused on cannabinoids, extracts, and oils, which are much more of a niche market within the cannabis space. Whereas dried cannabis is almost commoditized because of its rapidly increasing supply, oils and extracts aren't, allowing them to sport higher price points and significantly juicier margins. Cannabis producers that place added emphasis on oils and extracts should have healthier margins and be able to better withstand domestic oversupply, should it rear its head.
Nonetheless, it's also worth pointing out that Aphria's management team, including its CEO, disclosed insider stakes in Nuuvera just prior to the closing of the sale. Traditionally, investors would want to know about these insider stakes well in advance of a day before closing, as that could have influenced the premium paid for Nuuvera, as well as the desire to acquire the company. As a whole, Aphria's execs may have some atoning to do with investors who've lost confidence in management's late ownership disclosure, but I do personally still see value in the added distribution channels that Nuuvera brings to the table for Aphria.
Don't forget about these key partnerships
Additionally in January, just a few weeks prior to announcing these game-changing acquisitions, Aphria formed a strategic partnership with local greenhouse grower Double Diamond Farms. The deal with Double Diamond adds 120,000 kilograms of dried cannabis a year, more than doubling its original annual production estimate from its four-phase project.
But it's not just the expanded capacity that's worth cheering. It's the dealmaking that deserves the credit here. Aphria had expected to build out a 100-acre site in Ontario as its new source of capacity expansion. However, in doing so, it wouldn't have completed the project until sometime in 2020. That would have presumably given its larger foes more than enough time to snatch domestic market share. Forming a relationship with a local grower that has existing greenhouses will shave about a year off the time it takes Aphria to double its production, while leaving it with 100 acres with which to expand in the future, should demand outpace supply.
In December, Aphria also entered into an agreement with the roughly 1,300 Shoppers Drug Marts spread across Canada to be their licensed medical cannabis supplier. Even though recreational weed is a far larger market and generates greater long-term growth potential than medical cannabis, being the online supplier for a 1,300-store pharmacy chain is nothing to overlook.
In short, the new Aphria looks to be an even higher-margin company than before, with plenty of production capacity as of 2019. It's possible the costs associated with its recent acquisition push will end the company's two-year streak of full-year profitability, but Aphria's management team has regularly placed an emphasis on maintaining profitability in the past. In essence, it should be somewhat profitable again very soon. While it's tough to say what'll happen to the per-gram cannabis price given that there is no precedent for legalizing adult-use weed, Aphria now appears to be in much better shape than most Canadian pot stocks following its acquisition and partnership spree.