A Hurdle Of Their Own Making
Despite what looks like a great rebound in the Canadian cannabis market investors are warned. The entire industry is suffering from a sickness of its own making that has nothing to do with COVID-19. A look at the charts will show you this market took on a decidedly bearish tone nearly two years ago when recreational use was legalized. What’s the problem? Too much hype, not enough action.
If you’ll remember, it was just 24 months ago that virtually all analysts were gushing over the Canadian cannabis market because of its potential. By all accounts, the market should be worth over $5 billion and yet annualized sales have only now reached 50% of that mark. Adding to this is the rapid expansion spurred by the hype. Companies like Aphria (NYSE: APHA), Canopy Growth Corporation (NYSE: CGC), and Hexo (NASDAQ: HEXO) were spending like mad in attempts to dominate a market that never materialized. Now, and Aphria’s 3rd quarter results are evidence, those issues are coming to full fruit.
Growing, More Efficient, But Losing Money
Aphria made shocking news last year and early in 2020 when it began to slow expansion and capital bleed. It was good the company realized its mistake but perhaps it was too late. The third-quarter results, which show nice growth on a YOY basis, also support the idea of continued oversupply and downward pressure on profitability if not prices for cannabis. On the top line, Aphria brought in C$152.2 million or up 18% from last year. This beats the analyst’s consensus by 260 basis points but, quite frankly, wasn’t enough to support share prices.
On the bottom line, on a GAAP basis, the company lost C$98.48 million last quarter. That was a surprise that adjusted EPS was not able to overcome. At the adjusted level earnings were positive and slightly above estimates but small and compounded by the internal data. In terms of Kilograms sold the company sold less weed, about 12% less which may make it seem like prices for cannabis are rising. They’re not, at least not significantly. The company’s revenue growth is due more to efficiencies related to production.
On a cash basis, the cost of each kilogram sold is falling. The bad news is that all-in cost remain flat. When you add in the fact that production continues to scale, kilograms produced grew 68% quarter to quarter, the outlook for higher realized prices does not look good. If anything, the company and industry will lower prices to sell more products or wind up taking a loss on expired cannabis some time down the road.
“The Company maintains ample production capacity to meet its current and near-term demand in Canada and abroad.”
To be fair, a large portion of the loss is due to “business under development”. The Canadian government legalized derivative products at the end of last year and that sparked a round of new investment by Aphria. The new investment includes extraction and production facilities for vape and edible products, categories that are expected to command 13% to 18% of the market once matured.
The Technical Outlook: Aphria Might Have Bottomed
I want to start this section by saying I like the cannabis market. I think it has a lot of potential but it’s a long-term potential, one that will only be realized once Canada’s market has matured … and the U.S. grants nationwide legalization. Any investment in Aphria or any cannabis business is speculation on those two events. Now, Aphria’s news is not good for the near-term but continues to show the promise of cannabis long-term. This company is still a leader in the market and positioned to stay that way for the foreseeable future.
On a technical basis, share prices confirmed with stunning force. Share prices tanked nearly 20% in one day sparking an instantaneous bear market. Today’s action has them up about 3.5% in the early pre-market action but I am not a buyer, not yet. I think shares are going to see additional pressure in the coming weeks and months that could take them back to the $4.00 level if not the $3.00 or $2.00 level.
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