Just Another Tidbit Deep Value, value, contrarian, special situations
Summary
The management team at Aphria announced blow-out results for its latest quarter, with almost all of its metrics shooting sky high.
Add to this the firm's strong expectations for its now-current fiscal year and it's certainly hard to ignore.
Investors should remain cognizant of prior allegations and apply some margin of safety there.
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Right now, the cannabis space is volatile, uncertain, and a number of the players have, in recent weeks, been beat down as optimism over the market wanes. Though these trends are likely to continue for now, one benefit that comes with all of this volatility and uncertainty is that the companies that surprise in ways the market did not anticipate can easily be rewarded handsomely, as can their shareholders. Such appears to be the case with Aphria (APHA), a major but controversial player in the cannabis space that managed to give shareholders a blowout quarter that sent optimism for the firm spiking. Though it’s likely the easy money has been made off the firm now, so long as the company continues to perform as it has, shareholders should be happy about where they are long term.
Management crushed it
Late last year, Aphria became one of the most controversial cannabis companies on the market due to rather persuasive arguments alleging fraud within the firm. Since then, management has cleared up the issues at hand, but once a firm has those allegations lobbed at it, there's a little uncertainty that something negative can be hanging up in the company’s closet. As time progresses and management reveals the results of its execution strategy, these problems move further into the past and, based on the fact that in response to its fourth quarter earnings release, shares roared higher to close up 41% on Aug. 2, it looks like the tide has finally turned in the firm’s favor.
According to management, the latest quarter for Aphria was a strong one. Net revenue, for instance, came in at C$128.57 million. This represents a significant increase over the C$73.58 million the company reported just one quarter earlier, and it was more than 10 times higher the C$12.03 million in net revenue the company generated the same quarter last year. Seeing such a strong year-over-year, and quarter-over-quarter, revenue increase can be attributed not only to legalization trends in Canada and other parts of the world, but also are due to how well the company has succeeded in growing both organically and through acquisitions.
As a result of strong growth, plus an emphasis by management on cost controls, the company finally managed to earn a profit. During the quarter, profits came in at C$15.76 million. This compares favorably to the C$4.99 million loss seen in the fourth quarter last year. Back then, at a time when only medical cannabis was legal in Canada, most small firms in the space operated at a loss, but now that the industry has prioritized growth over earnings, many of the larger players in the space are still coming up short on this front.
Based on the data provided, there were some major contributors to Aphria’s strong quarter. According to management, for instance, the company managed to produce 5,574kg (kilograms) of product in the latest quarter. This represents a more than doubling of sales compared to the 2,636.5kg the firm reported just one quarter earlier, with a sizable chunk of its revenue (C$99.2 million) coming from distribution related to its acquisition of CC Pharma and other distribution companies.
Production figures are great to see on the rise, but another positive has to do with pricing. Even though retail pricing declined from C$8.03 per gram down to C$7.66 per gram, this was due to the expansion of its medical cannabis business. Actual adult-use (aka recreational) cannabis pricing was bullish, with the price per gram rising from C$5.14 to C$5.73. This is one area I continue to watch carefully because with the rapid expansion of the cannabis market from a production capacity perspective, weakness in the space should come from declining recreational sales per gram before anyplace else. Fortunately for Aphria, the opposite is occurring, which means that the market for recreational users is doing fine and/or at least the company itself is able to have some competitive edge of many of its peers.
One other benefit for shareholders ties back to costs. The great thing about rapid expansion is that it opens the door to economies of scale, but opening the door for that and actually achieving it are two entirely different things. Fortunately for investors, it appears management is doing well on this front, because during the fourth quarter, it managed to see its cash costs per gram average just $1.35. This represents a modest improvement over the C$1.48 per gram seen a quarter earlier. All-in costs (cash plus non-cash) also fared well, falling from C$2.86 per gram in the third quarter to C$2.35 per gram today. Nobody knows how low costs can go, but rival Aurora Cannabis (ACB) has painted the picture of it at least achieving cash costs lower than C$1 per gram before too long. If Aphria can achieve similar scale, the impact spread across the firm could result in tens of millions of dollars per annum.
For its 2019 fiscal year as a whole, Aphria managed to see revenue of C$237.11 million and off of that it saw adjusted EBITDA of C$27.72 million. For its 2020 fiscal year, the company expects the picture to change dramatically. If all goes according to plan, the firm expects that revenue will range between C$650 million and C$700 million and EBITDA will be between C$88 million and C$95 million. This likely points to a net profit for the year or awfully close to it, which would make the company fully self sustaining, especially when you add to it the C$550.80 million in cash and cash equivalents, plus C$20.20 million in marketable securities on the firm’s books.
Takeaway
At this moment, there are several cannabis firms that investors in the market can choose from, and generally speaking, I'm cautious regarding any firm that has received allegations of fraud against it. That said, Aphria’s strong performance here and the expectation of continued growth and, possibly, the turn of the company to profit for 2020, all points me to say that it’s one of the most interesting players in the space at the moment. I do believe that some margin of safety needs to be applied here for the time being because of the aforementioned allegations, but for long-term investors willing to accept that risk, now might be the time to consider buying in if they haven’t already.