Aphria (APHA) failed to deliver the expected breakout quarter on October 15. The Canadian cannabis company continued a pattern of results failing to live up to expectations despite reduced targets and generally market leading financials. My investment thesis remains constructive on the stock when trading in the $4’s like it is now.
My One Concern
The biggest concern with Aphria was how the company would handle the increased production from the Aphria Diamond facility that came on-line at the end of 2019. The Canadian cannabis market was vastly oversupplied, and the 140,000 kg facility was set to contribute to the flood of weed on the market as the production capacity of the company jumped to 255,000 kg.
For FQ1 ended August 31, the company reported revenues slumped to C$145.7 million, or C$14.0 million below analyst expectations. It even missed EBITDA targets, but the issues causing these two misses were different.
Again, this is the problem with the stock gaining any traction. The revenue miss was primarily due to the distribution business with low margins seeing revenues fall due to COVID-19 slowdowns in Germany. CC Pharma operates a medical cannabis business in the European country and saw revenues fall C$17.0 million from the prior quarter.
The distribution revenue generally accounted for most of the revenue miss, but the net cannabis revenue played a big part in the EBITDA miss. While net cannabis revenues were up 18% sequentially to a record C$62.5 million, Aphria saw Canadian recreational prices and margins slump on the rollout of a new lower-end value brand along with lower orders from provisional control board despite larger sell-throughs.
The end result was the company sold 66% more kilograms at 20,882 in FQ1 with very limited benefit. Total adjusted EBITDA only grew from C$9.4 million in the prior quarter to C$10.4 million in the August quarter.
Due to the shift to the B!NGO value brand, Aphria saw the ASP of adult-use cannabis slump to C$4.15 per gram, down from C$5.23 per gram. The end result was a 320-basis-point reduction in gross margins to 49.7%.
Not many industries pay hundreds of millions to build a new state-of-the-art production facility in order to lower ASPs by over 20% in one quarter. Sure, the company is still attempting to take business from the illicit market, but a better option needs to exist other than flooding the market with low-margin weed.
The good news is that Aphria is very EBITDA positive now and has a path to cash flow positive as capital spending drops to only a few million dollars a quarter. The bad news is that the Canadian cannabis sector still appears unable to grow sales without damaging margins and ASPs.
CapEx was C$17 million in FQ1 due to work to complete the German cultivation facility. Aphria will spend another C$8 million to C$13 million in the current quarter on German expansion with minimal spending afterwards.
The company has cut production starting with the September crop, because the biggest problem in the business remains the inventory build. Aphria grew the inventory balance by C$57.0 million in the August quarter, contributing to the $C97 million decrease in the cash position in the quarter to C$400 million.
Source: Aphria FQ1’21 financial statements
Even with these issues, Aphria expects the provisional de-stocking to end soon, leading gross margins to return to the 53% range. Despite this issue, Cantor Fitzgerald cut the price target to C$11.75, or the equivalent of ~$9.00. Aphria is still nearly a double to hit this price target with the stock down in the mid-$4’s. Cantor has the company hitting FY21 EBITDA of C$61 million and FY22 at C$128 million.
The concern going into the FQ1 report was the pattern of growing net cannabis revenues while missing targets. The stock won’t obtain premium valuations until investors have confidence in the sector. Despite nearly unanimous Bullish ratings on Aphria and a price target of nearly $9, investors aren’t snapping up the stock.
The key investor takeaway is that Aphria remains the best stock in a struggling sector. The stock offers value trading at ~15x FY22 EBITDA targets with substantial growth opportunities in Canada and international operations. Buy Aphria in the $4’s after the market gets over the disappointing FQ1 results and hold the stock until better results send the stock higher.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in APHA over 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.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.