Unpredictable doesn’t even begin to describe cannabis producers Aphria [APHA] and Tilray’s [TLRY] share price performance in February. The two stocks saw huge price movements, including some steep drops thanks to an overvaluation triggered by WallStreetBets hype.
Tilray's share price opened on 1 February at circa $11. By 11 February, it closed at $63.91, marking an increase of over 250%. However, Tilray's share price gains proved unsustainable, with the stock closing last week at $29.21.
Aphria's share price has had a similar trajectory. Having started February trading around the CA$12 mark, the stock closed at CA$33.37 on 10 February. Like Tilray, Aphria’s share price rally was unsustainable, with the stock trading near the CA$20 mark by Friday 12 February. Since then, it has staged a partial recovery to close near CA$25 on 19 February.
This volatility left cannabis as one of the losers on our Global Thematic ETF Screener last week, slipping 2.73% (as of 19 February’s close).
Yet there are many factors in play for both of these Canadian cannabis producers. These include a proposed merger between the two, a Democrat-controlled White House and the prospect of improving earnings.
So, what is the outlook for Tilray and Aphria’s share prices ahead of their union?
Growth drivers for Tilray and Aphria’s share price
December saw Tilray and Aphria announce that they will merge, creating the world’s biggest cannabis company by revenue in the process.
Aphria shareholders will receive 0.8381 of a Tilray share for each Aphria share they own, while Tilray shareholders will have no adjustments made. The deal is expected to conclude in the second quarter of 2021, with Aphria becoming a wholly owned subsidiary of Tilray.
According to MarketWatch, Cantor Fitzgerald analyst Pablo Zuanic thinks investors looking to profit from the planned merger are better off buying Aphria. Zuanic argues that Aphria is trading at a 51% discount and has set a $25.71 price target on the stock, along with a $30.25 target on Tilray.
“The merger is timely as it strengthens the combined company’s ability to take advantage of potential U.S. federal legalization,” said Jason Wilson, cannabis banking and research expert at ETFMG, according to MarketWatch.
Access to US markets will soon become incredibly important for Canada’s cannabis producers, as Democrats are now in charge of all three branches of the US federal government.
On the campaign trail, the Biden-Harris administration ran on a ticket that included a pledge to decriminalise marijuana sales at a federal level.
“Democrats will decriminalize marijuana use and reschedule it through executive action on the federal level,” according to the Biden-Sanders Unity Taskforce Recommendations document, posted on joebiden.com.
Public and political support for legislation at a federal level has never been greater. According to The Verge, a recent Gallup poll shows 68% of Americans approve legislation, while in the November election four more states approved cannabis reform laws.
So far, 15 states have already legalised the drug, with New York looking to legalise cannabis this year in order to generate tax revenue. In December, the House of Representatives passed the MORE act, which decriminalises marijuana use.
Just how far the White House is prepared to go remains uncertain — Biden’s task force document reads “decriminalise”, not “legalise”. However, with the Democrats controlling both the House and the Senate, now could be the optimal time to pass legislation.
If that happens, the merged Aphria and Tilray’s share price could fly.
Certainly one of the big drivers for Tilray and Aphria’s share price movements has been recent quarterly results beating analyst expectations.
On 17 February, Tilray posted a net loss of $2.9m, or two cents a share, beating Wall Street's predicted net loss of $0.14 a share. Overall sales hit $56.6m in the quarter. Following the better than expected results, Tilray's share price jumped 14.7%.
Aphria posted an adjusted EBITDA of $12.6m in its quarterly results — its seventh consecutive positive quarter.
“Amid an acceleration of regulatory changes and an increasingly-favorable political environment, our proposed merger with Aphria will position the combined company as a global leader with lowest cost of production, leading brands, a well-developed distribution network, and unique partnerships,” Tilray CEO Brendan Kennedy said in the earnings release.
Kennedy also pointed to $78.7m worth of tax efficiencies that would "generate significant value for stockholders" as a result of the merger.
D. H. Taylor, writing on Seeking Alpha, points out that the two combined companies will have a valuation of approximately $9bn, adding this note of caution:
"Consider what it would take to have a $9B valuation for a 'normal' company. The combined companies would be earning about $300M in net profits to merit the $9B price tag."
Taylor warns that “neither company is consistently profitable”, and doesn't see the “current valuations being pragmatic”.
Taylor has a point, and it’s something long-term investors need to bear in mind before investing. However, should cannabis laws be relaxed at a federal level in the US — or even more individual states give the green light for recreational use — then momentum could see a surge in the stocks, even if this is out-of-kilter with the newly-merged company’s fundamentals.
Source: This content has been produced by Opto trading intelligence for Century Financial and was originally published on cmcmarkets.com/en-gb/opto