In 2019, in the cannabis sector, Aphria (APHA) was one of the bright spots in a mostly dismal year for most of its peers.
Among the reasons investors have liked Aphria is its international exposure, significant cash reserves, being among the leading producers, and its ability to generate a couple consecutive quarters of slight profits in 2019.
In this article we’ll look at why the optimism surrounding Aphria is starting to dwindle, and why it’ll be hard to meet expectations in 2020.
Latest earnings
In its last earnings report that ended in November 2019, the company had net revenue drop from C$126.1 million in Q1 to C$120.6 million in Q2. Gross profits in the quarter fell from C$45.2 million in Q1 to C$39.59 million.
Revenue from distribution also fell from C$95.3 million to c$86.4 million. It also generated a loss of C$7.9 million in the reporting period, versus a profit of C$16.4 million in the prior quarter.
Probably the most important of those numbers was the drop in gross profit, which point to lower prices, declining demand, or both. Also significant is the drop in gross profit didn’t come from marketing or spending on R&D, which would have the potential to generate a return for the company. It also means the company will probably cut spending on marketing and R&D going forward.
What this also suggests is it isn’t probable that Aphria will generate another profitable quarter anytime soon.
As a result of the weak performance in the last quarter, the company unsurprisingly cut its revenue guidance for 2020 from C$675 million in October, to C$600 million.
Revenue in the first half of its fiscal year came in at C$246 million. In the second half of its fiscal year it projects sales of C$354 million. While that’s a 44 percent increase over first half sales, its relatively high price-to-sales ratio of 9 means the increase isn’t that great.
Even though the stock was down about 35 percent last year, which was better than many of its peers, its shrinking profitability and high valuation point to deeper struggles in 2020 and beyond.
Derivatives and store openings
Most of us know that all the cannabis companies based in Canada probably aren’t going to benefit much from the legalization of derivative products in the country in the first half of the calendar year, and probably longer.
With the weak guidance of Aphria, it suggests it may underperform many of its peers in derivatives, where expectations are already low for the short term.
Weak guidance also points to Aphria not expecting the new store openings in Ontario, and to a lesser degree, Quebec, to have much impact on the top and bottom lines of the company.
The potential good news there is anything that exceeds current expectations would result in surprising the market, which would give its share price a boost, because low expectations are already priced in.
Conclusion
Since the low number of retail outlets to sell cannabis out of has brought about more supply and demand, the price of marijuana has dropped in Canada. It has also allowed black market competitors to thrive, which has also put downward pressure on prices in order to win share from the illegal market.
I think the company will struggle in the near term to maintain its past gross profits, and will find it difficult to repeat the profitable quarters it had in 2019. That suggests to me the company is overvalued and is likely to fall more in the first calendar half against some of its competitors, because they’ve already taken the big hits from the market.
Until we find out what the real demand in Canada is, by which I mean hundreds of more stores are opened, it’s going to be hard to accurately project the performance of Aphria and other Canadian-based companies.
Aphria does have a significant international presence, but those markets have been growing incrementally, and it’ll take time for that to become a big factor in its performance.
I see Aphria, because of the positive sentiment of many bulls concerning the company, having the potential to fall the most of its major peers in 2020, but also because of its strengths, if it does manage to surprise, it could surprise to the upside.
Taking everything together, it’s far more likely that Aphria will tumble in 2020, rather than improve its performance.
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