YES, I KNOW THIS IS JUST ANOTHER CUT AND PASTE ARTICLE, BUT THERE ARE SOME GOOD NUMBERS IN IT TO DIGEST. READ UP. WE JUST NEED A PUSH TO GET US THROUGH RESISTANCE.
Welcome to our Cannabis Earnings series where we break down the latest earnings to help you focus on the most important topics.
Introduction
On April 14, Aphria (APHA) reported fiscal 2020 Q3 results that exceeded investor expectations. While the stock remains battered by the ongoing pandemic and investor apathy towards cannabis stocks, we think the fact that Aphria has held up relatively well compared to its peers is a testament to its high-quality asset base and solid financial position. As we concluded before, we think Aphria remains a top pick in Canada thanks to its balance sheet and production capacity. We expect Aphria to lead the recovery in the second half of 2020 and 2021 once the market stabilizes.
(Amounts in C$)
Fiscal 2020 Q3
Aphria reported a strong quarter with net cannabis sales up an impressive 64% for the three months ended in February 2020. The growth was driven by a large increase in sales to Canadian provincial buyers and a large jump in wholesale sales. Medical cannabis sales fell slightly, but it is now a small part of the overall sales mix. Distribution revenue remained soft and essentially flat from the previous quarter. Gross margin before fair value adjustments was flat at 25% while EBITDA margin improved to 10%.
(Source: Public Filings)
The growth in cannabis sales was driven by higher sales volume offset by lower realized pricing. Last quarter, Aphria sold a total of 14k kg of cannabis across its distribution channels including a 47% increase in recreational sales. Wholesale also increased by a large percentage as the company ramps up production. Aphria harvested a total of 32k kg last quarter which is an increase of almost 130%, supported by the continued ramp at its 1.3 million square feet Diamond facility. However, Aphria, actually, had to buy additional cannabis supply from the wholesale market totaling $20 million as demand exceeded production in the quarter. We think the reason why Aphria had to purchase externally while harvest exceeded sales volume was due to a combination of delay between harvest and processing and flower quality. We do expect to see improved margin in the coming quarters as Aphria indicated that gross profit and EBITDA would have been $7.6 million higher without these external purchases.
(Source: Public Filings)
Pricing remained largely flat for recreational sales while medical cannabis pricing dropped substantially due to compassionate pricing in the quarter. Aphria offers a 20% discount to customers with annual incomes of less than $30k. The company also, substantially, increased its sales to the wholesale market which carries materially lower margin - Aphria doesn't disclose it but our math shows wholesale pricing of $2.46 per gram which is roughly in-line with what other LPs have reported. As a result, consolidated realized pricing dropped to $3.81 per gram during the quarter compared to $5.54 per gram last quarter. Going forward, we expect pricing to remain the focus for investors as many LPs have moved down the pricing spectrum to allure price-conscious customers while competing directly with the black market which will likely further compress margin and profitability.
(Source: Public Filings)
Solid Balance Sheet
In times like this, a strong balance sheet can be used as a strategic asset, and Aphria is benefiting from its foresight of obtaining financing on its assets while capital markets remained cooperative. During the last six months, Aphria completed several strategic financing activities including a $100 million equity investment from an unnamed institution at a price of $7.12 per share (currently shares trading at $5.08) and an $80 million bank financing for its Diamond cultivation facility. At the end of last quarter, Aphria has a total cash balance of $515 million which is among the highest in the sector. In fact, only Canopy (CGC) and Cronos (CRON) have a higher cash balance only because they both have a corporate sponsor, namely Constellation (NYSE:STZ) and Altria (NYSE:MO). We think Aphria's balance sheet is a core strength for the stock and should provide support for its share price while offering strategic flexibility to pursue opportunistic acquisitions and expansions.
(Source: TSX)
Aphria, currently, has a market capitalization of $1.2 billion and an enterprise value of $1.3 billion. It has $138 million of straight debt in addition to $470 million (US$350 million) of convertible debentures issued in 2019 bearing an interest rate of 5.25% at a conversion price of $9.38 per share. The company trades at an EV/Sales of 2.3x on a consolidated basis or 5.8x based on just cannabis net revenue excluding distribution. Aphria is relatively cheap compared to its large-cap Canadian peers such as Canopy at 12x, Cronos at 7x, Aurora (ACB) at 7x, and Tilray (TLRY) at 7x. We think the discount is unwarranted based on Aphria's latest execution, industry-leading balance sheet, and one of the most efficient and at-scale production footprint. We expect Aphria shares to outperform on a relative basis as it continues to take market shares from other LPs and benefit from its scale.
Looking Ahead
Aphria remains one of our top Canadian picks after its positive Q3 results. The company is taking share from other LPs such as Aurora and is fully-funded with major production facilities complete and fully ramped up. With over $500 million in cash and no near-term debt maturity, Aphria is well-positioned to weather the current downturn and emerge as one of the survivors in the Canadian market. Consistent with our long-held view that the Canadian market is going through a shakeout phase that will leave a small number of LPs surviving the downturn, we think investors need to be very selective when investing in this sector. We are confident that Aphria will become one of the long-term players in the industry. However, despite the relative attractiveness of Aphria, we think the shares are unlikely to move much higher given the challenging state of the Canadian cannabis market and heightened equity market volatility amid COVID-19. We are cautious about the whole Canadian cannabis sector in the near term due to the ongoing pandemic and would prefer waiting for better entry opportunities and signs of stabilization in the industry. When the market turns, we are confident that Aphria will lead the way in terms of growth and performance.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.