Aphria’s deal to buy SweetWater Brewing is a good one, says Haywood

Haywood Capital Markets analyst Neal Gilmer likes the new craft brewer acquisition in the United States by cannabis company Aphria (Aphria Stock Quote, Chart, News TSX:APHA), saying in an update to clients on Thursday that the deal adds diversification of Aphria’s lineup ahead of a potential legalization of cannabis in the US.

Leamington, Ontario-based Aphria, a licensed cannabis producer with current approved capacity of 255,000 kg per year, announced on Wednesday an agreement to buy Atlanta, Georgia-based SweetWater Brewing Company for a purchase price of approximately US$300 million including US$250 million in cash and the rest in stock, along with up to $66 million in additional cash earnouts up to 2023.

SweetWater has distribution across 27 states plus Washington, DC, with beverages at about 29,000 retail locations and more than 10,000 restaurants and bars. In 2019, the company’s 420 Strain G13 IPA became the top new craft brand in the US for the first 12 months after launch. Last year, SweetWater had revenue and adjusted EBITDA of $66.6 million and $22.1 million, respectively.

Aphria said the deal will be immediately accretive and that SweetWater’s brands are closely aligned with a cannabis lifestyle, noting the company’s 420 Fest annual music festival and beers which have flavours and aromas associated with cannabis strains. Calling it the cornerstone of Aprhia’s longer-term US strategy, APHA says the merger will create a combined branded cannabis lifestyle products company with significant cross-selling and market expansion opportunities.

“Our strong balance sheet and access to capital have enabled us to enter the US through this strategic and accretive acquisition,” said Irwin D. Simon, Aphria’s chairman and CEO, in a press release. “We will establish and grow our US presence through SweetWater’s robust, profitable platform of craft brewing innovation, manufacturing, marketing and distribution expertise. At the same time, we will build brand awareness for our adult-use cannabis brands, Broken Coast, Good Supply, Riff and Solei, through our participation in the growing $29-billion craft brew market in the US ahead of potential future state or federal cannabis legalization.”

Gilmer said the deal, which is expected to close before the end of 2020, represents a 12.5x EBITDA multiple for Aphria, which should be funding the buy through a US$100-million term debt facility, up to US$100 million from its existing at-the-market equity program and cash on hand.

“Aphria is acquiring robust infrastructure that is scalable and would substantially accelerate entry into the US cannabis market, subject to federal legalization,” Gilmer wrote. “SweetWater products are currently distributed in 27 states, with a two-and-a-half year expansion plan to be in all 50 states.”

The analyst figures on a combined basis the two companies have annualized pro-forma revenue of between $650 and $675 million with adjusted EBITDA of between $65 and $70 million. Gilmer said while sales have slowed for SweetWater due to the pandemic, the company has still put up impressive EBITDA margins of 39.7 per cent on US$40.2 million in revenue for the last 12 months ending August 30, 2020. (All figures in Canadian dollars except where noted otherwise.)

“We view this transaction positively for the diversification and brand awareness opportunity ahead of a potential legalization in the US,” Gilmer wrote. “In the meantime, it is an accretive transaction generating positive EBITDA. We have not included SweetWater in our estimates at this time and will do so on closing.”

On the numbers, Gilmer thinks Aphria will generate fiscal 2021(year end May 31) revenue and adjusted EBITDA of $665.5 million and $66.8 million, respectively, and fiscal 2022 revenue and adjusted EBITDA of $843.7 million and $148.7 million, respectively.

With the update, Gilmer has maintained his “Buy” recommendation on APHA as well as his $8.25 target price, which at press time represented a projected 12-month return of 27 per cent.

“We continue to view Aphria as a leader in the Canadian LP landscape,” Gilmer said. “We expect the company will continue to demonstrate its leading position, supported by revenue growth and expanding EBITDA margins in fiscal 2021.”

Aphria last reported earnings last month where its fiscal first quarter ended August 31, 2020, featured net cannabis revenue up 103 per cent year-over-year to $62.5 million and net revenue up 16 per cent year-over-year but down four per cent sequentially to $145.7 million. Adjusted EBITDA rose from the previous quarter by 17 per cent to $10.0 million, while the company posted a net loss of $5.1 million or $0.02 per share. Analysts had been calling for revenue of $159.6 million and a loss of $9.5 million.

In its Q1 commentary, management said Aphria’s brands continue to see robust growth in the Canadian rec market and that its strong balance sheet and cash position will help generate long-term value for the company and its stakeholders. Aphria ended the quarter with $400.0 million in cash and equivalents