Should You Buy Into Aphria’s Buying Spree?

Aphria (NASDAQ:APHA) stock is moving higher after the cannabis company reported an unexpected adjusted profit of one cent per share. Investors have taken notice and shares of APHA climbed nearly 10% in early morning trading on January 14.

The positive earnings report is a welcome confirmation for investors who may have been on the fence about Aphria’s planned reverse merger with Tilray (NASDAQ:TLRY) that the company confirmed will be complete in the second calendar quarter.

When the acquisition is complete, Aphria will become a subsidiary of Tilray and the company will trade under the TLRY ticker.

What Are The Benefits to the Merger?

Aphria gets a production boost while maximizing the efficiency of Tilray’s facilities. Aphria also will get to revamp its Cannabis 2.0 offerings with access to Tilray’s deal with Anheuser-Busch InBev (NYSE:BUD). The companies were developing cannabis-infused beverages through their Canadian Labatt’s brand.

The company also gets broader access to the U.S. hemp market. Tilray generates 40% of its total revenue and is already seeded in several grocery chains such as Costco (NASDAQ:COST), Whole Foods and Kroger (NYSE:KR).

The Consolidation Phase Has Begun

The cannabis sector is moving into the next phase of growth. Out of necessity, this meant that consolidation was going to occur. There is an expectation that the Aphria-Tilray merger will spark renewed interest in the cannabis sector.

As many investors know, some for very painful reasons, cannabis stocks were ravage as part of a spectacular bubble that burst in 2019. The sector has faced numerous obstacles. Initially some of the wounds were self-inflicted. However in the last year and a half, cannabis companies have been dealing with many issues out of its direct control.

For example, legalization in Canada did not take off as quickly as expected. And while the bottlenecks that existed early have largely given way, the sector is still trying to position itself to take advantage of an easing regulatory environment inside the United States.

The de facto leader, Canopy Growth (NASDAQ:CGC) has benefited greatly from the cash infusion it has received via Constellation Brands (NYSE:STZ). But for the rest of the sector, consolidation needed to happen.

And with the Tilray merger, Aphria is leading the way. However, Tilray is not the only acquisition that is generating excitement for Aphria stock. The company also recently paid $250 million in cash (plus an additional $50 million in stock) to purchase the U.S. craft beer company, Sweetwater which focuses on “cannabis lifestyle” in its marketing.  

The acquisition of Sweetwater gives Aphria/Tilray the chance to seed its name in the United States. The potential to build brand awareness may prove to be advantageous when the U.S. finally legalizes marijuana.

But aside from the marketing angle, Sweetwater should not hurt Aphria’s bottom line. Sweetwater is already cash flow positive.

It’s Time to Reconsider the Cannabis Sector

There is some sentiment that Aphria is overpaying for Tilray. However that will become inconsequential if the combined brands prove to investors that they are better together. It’s hard to imagine that Aphria won’t benefit from this merger.

This isn’t a prediction on the imminent legalization of marijuana in the United States. That’s not likely to happen as soon as investors would like. The incoming administration has a lot on its plate, and I can’t imagine that legalization will be high on its agenda.

But at some point in the next four years, it’s likely that legalization will become more likely. And when that happens, this merger is putting Aphria in a better position to gain access to this market.

The one caveat I would offer is that growth through acquisition is a strategy that has its limits. The new entity must show that it can realize economies of scale. Otherwise the company will have to just continue to absorb other companies. And that’s a strategy that rarely works out well.

Cannabis stocks are still a speculative bet. But it’s a bet that is starting to look a lot less risky than before.