Aphria Financial Results Were Eye Opening

Aphria Inc. (TSX:APHA), one of the Canadian marijuana stocks, reported Q1/20 financial results before markets opened on October 15, 2019

SmallCapPower | October 16, 2019: Aphria Inc. (TSX:APHA) (NYSE:APHA), one of the Canadian cannabis stocks, reported Q1/20 financials on October 15, 2019, before markets opened. Results were highlighted by EPS of $0.07 on net cannabis revenue of $30.8M and net revenue of $126.1M, which was mixed compared with consensus estimates of $131.1M in net revenue and EPS of ($0.03). Management also reiterated F2020E revenue guidance of $650M to $700M and adj. EBITDA of $88M to $95M.

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Figure 1: Financial Highlights

Source: Ubika, Company Reports

Cannabis revenue increased 7.6% QoQ. Q1/20 net revenue was $126.1M, a decrease of 1.9% QoQ. The decrease was due primarily to a 3.9% slip in distribution revenue to $95.3M (was $99.2M), which was associated with a change strategy with CC Pharma revenue model after changes in the German government’s medical reimbursement policies. Cannabis revenue increased 7.6% to $30.7M, driven by a 7.9% rise in recreational revenues while medical revenues remained flat. Cannabis kilogram and kilogram equivalents sold during the quarter were up 7.1% to 5,969 kg.

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Cannabis gross margins contract by 3%. Cannabis gross margins came in at 50%, a decrease from 53% in Q4/19. Gross margin contraction can be attributed primarily to allocation of some production space at AphriaONE for mother plants that will be transported to Aphria Double Diamond (DD) once the facility has been approved by Health Canada.

Cash cost per gram increased by 5.9% to $1.43, due primarily to management’s strategic decision to allocate mother plants to DD. On the earnings call, management said that shareholders should expect cash costs per gram to increase until DD ramps up and once DD is in full production cash costs are expected to decrease.

Operating expenses decreased by 33.6% to $41.4M (was $62.3M). The decrease was driven mainly by $19.5M in lower transaction costs, which were associated with issuance of convertible debt in the prior quarter. CFO Carl Merton mentioned that cash burn (~$100M) was abnormally high and was largely a result of a one-time ~$35M earnout related to milestones hit with the CC Pharma transaction, ~$40M in capex, and a ~$15M increased working capital. Mr. Merton mentioned that capex should normalize to $20M – $25M next quarter and working capital should decrease as well.

Reiterated net revenue guidance of $650M to $700M and adj. EBITDA of $88M to $95M for F2020E. Distribution revenue is expected to represent slightly more than half the total net revenue, meaning that Canadian cannabis net revenue is expected to be ~$300M. This implies that Aphria will need to generate ~$270M of cannabis revenue for the remaining three quarters of F2020. During the earnings call, management mentioned that the majority of this growth should come in Q3/20 and Q4/20 once edibles and concentrates revenues begin to materialize.

Figure 2: Revenue Growth Required to Meet Guidance

Source: Ubika

This revenue guidance is likely rich. Aphria would have to increase cannabis revenue by 25% next quarter and then double revenue in the two subsequent quarters to meet this target. Risks in achieving this target include poor rollout of retail stores in Ontario and Quebec. While Ontario and Quebec are expecting to rollout 42 and 25 stores, respectively, over the next few months, this is unlikely to support the triple-digit growth required to meet the target. In addition, there may be delays in the rollout of edibles, as Health Canada still needs to approve packaging. Cultivators can begin to submit proposed packaging on October 17, 2019. Given Health Canada’s poor rollout of Cannabis 1.0, it is unlikely Cannabis 2.0’s rollout will be much better.

Key Takeaways. Aphria Q1/20 results were mixed; EPS beat analysts estimates while revenue missed. However, it was not a blow-out quarter as growth in net cannabis revenue was up only 7.6%. EPS was positive but this was due mainly to fair value (FV) adjustment of biological assets and other income. Aphria reported a $14.2M gain on the value of its convertible. In other words, the Company made a profit from its decreasing share price. This is because IFRS accounting rules require APHA to adjust convertible debt as conversion of the convertible to equity becomes less likely when the share price falls far from the conversion price. The convertible converts at US$9.38 (C$12.40) and comes due in 2024 with an interest rate of 5.25%. Aphria’s operating income (gross profit before FV minus OPEX) is still sitting at a loss of $13.9M. Additionally, based on current sales, Aphria has ~2 years of inventory on hand, while a lot of this is earmarked to be extracted for use in Cannabis 2.0. This could be an indication that cultivators will face further margin compression.

Aphria is still well undervalued compared with peers. Aphria trades at a F2020E EV/sales multiple of 2.5x, compared with large-cap Canadian cultivators, which trade at an average F2020E EV/sales multiple of 13.7x. Aphria has very low costs leading to some of the lowest prices, with 3.5 grams of Solei selling for ~$26.50 in the OCS. This means that Aphria should be able to weather any looming price competition and still maintain its market share. Aphria also has ~$450M in cash on hand, which we view as a positive as there may be a liquidity crisis looming in the cannabis sector.

Shares of Aphria closed Tuesday’s trading session up 16% to C$7.17. Aphria stock trades at a market cap of C$1.6B.

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