The cannabis industry has been suffering from a serious case of too much supply and not enough demand. Many companies rushed into the industry in search of green profits after legalization in Canada in 2018. From that, stocks have sold off precipitously over the past year. Now, given a fresh perspective, the question is can these badly beaten stocks offer an opportunity for a long-term investment.
With regards to Aphria (NASDAQ:APHA), I wanted to look at the financials of this company and see what future could be for an investor. After review, although I felt there was some hurdles with the company, I believe over a few years' time, there would be opportunity. However, I will state upfront, at the current price ($4.67), I do not have a warm fuzzy feeling buying this stock at this time.
Along with many cannabis stocks, the stock has sold off recently due to the industry's lack of demand compared to the amount of supply hitting the market:
First, a bit of a news on me. I had been covering cannabis stocks over the past few years since legalization. Long-term followers will have wondered where I have been over the past 1.5 years. Unfortunately, while traveling through Central America, I contracted a virus that took me out for over 12 months' time - no, not this virus, another one. Imagine my utter delight that once recovered, there would be a global pandemic from yet another virus. During the time of my fighting off my contracted virus, all of my holdings were sold off; I owned Aphria at one point. Now, I am approaching this stock with new fundamentals and a new landscape.
Looking at the financials of the recent quarter saw the company publish gross sales of $152M. There was an expected loss for the quarter of C$.03 per share. The actual loss was far worse at C$.39; the company wrote off some C$64 million due to COVID-19 expenses. At $0.03 per share loss, the market hoped that the company would have lost a mere $8M. But, they lost over 10x that at over $100M. Keep in mind, the company wrote down $64M for COVID-19 expenses. The read: There are other factors weighing on costs. I have not been able to parse out any of the information from the company's last conference call to learn why there were increased costs beyond the $65M, due to COVID-19. The company has cash now, approximately $350M. However, these costs need to be contained quickly and efficiently by the company to maintain its position and future viability.
Previous quarterly sales came in at $114M for Q4 2020 (an 18% increase from the year earlier at $96M). During that same quarter, the company saw a 28% increase in recreational sales. If this is linear, then the company can hope for further gains. But, their costs need to be kept in check as the rise in costs is outpacing the company's rise in sales.
Like any other company in the sector, there needs to be an increase in sales. So, where will management be looking for sales?
One of the key elements that the CEO is focusing on is legalization in the United States. However, I do not see this as a panacea. Canada, where Aphria is based, legalized recreational cannabis differently. Canada started at the federal level and then allowed the provinces to administer cannabis in their respective jurisdictions. In the United States, cannabis is illegal on the federal level, whereas some states have legalized recreational or medicinal cannabis, or both. Because of this backwards approach, many states have laws on the books that do not allow for them to distribute in other states.
Take Colorado for instance. If a company has a cannabis business in the State of Colorado, it may not sell its products in other states where cannabis is legal. Further, no company can license to another company in another state, start another company in another state nor partner in any other way. In other words, if you are a cannabis producer in Colorado, Colorado is your only market. Due to this, I do not see any kind of sales gain with a federal legalization of cannabis, that, at this point does not even seem to be anywhere in the near future.
Even if cannabis was legalized federally, no one knows whether or not Canadian companies would be permitted to sell their products in the United States. If the federal government legalized imports of cannabis, that would merely be one level of law that allows for importation. Many states have disallowed, via law, importation of cannabis products from other sovereignties. After the federal government were to potentially legalize cannabis, that does not necessarily mean that a state would allow it, nor be a simple process of amending a law to allow for distribution from Canada. So, when I hear CEOs talk about legalization in the US, I have a difficult time imagining that there is going to be a potential bonanza for cannabis sales. I think the approach is misguided.
I like that the company is working towards containing costs in their current operations, however. That is an imperative. In the beginning, a lot of these companies spent any money they could to build their infrastructure and get their products first-to-market. There was quite a bit of euphoria - no pun intended - in the future outlook of profits in this new sector of the economy. But, far too many companies showed up with far too much products to sell. And, all of these companies saw their businesses withdraw significantly.
One of the benefits that Aphria has is its access to capital markets; however, that could have downsides. They have recently authorized themselves a $100M At-The-Money offering of stock should they need to do so to raise more capital. Given the company just lost that amount in one quarter, albeit a quarter during a global pandemic, the company is likely to continue to lose additional money. I understand the $65M in write-offs due to COVID-19. I also understand the originally projected $8M loss - an amount that is very manageable. But, $65 + $8 = $73. They lost over $100M. What can we expect with the remaining $30M? Is this going to be a recurring quarterly theme?
Is Aphria a buy?
The way I see it, Aphria has to do these important things: Continue to cut its costs and increase sales until they reach a break-even equilibrium. If the company can continue to cut its costs (This quarter's 25% goes a long way) and avoid having to issue more stock, this will bode well. I would like to reiterate that at 18% growth in recreational sales, if that number is linear and sustainable, this would improve the sales numbers significantly. This is something I am going to be scrutinizing. Also, Aphria cut costs of SG&A to the tune of 25% and I want to know how much more we will see in coming quarters. There will have to be more and I believe this will be a key focus for the company as well.
Given these factors, I would buy Aphria. However, we do not know at this time if these factors are going to continue and get the company to its break-even level. For those that can stomach a bit of volatility, it may be that getting into this stock at this level would be rewarding in a long-term trade. For me, I will remain neutral and wait for further information.
