Aphria (APHA) sank nearly 20% following FQ4 results as the market expected a much better quarter. While the top-line results were solid, the cannabis company appears headed down the path of other failed cannabis stocks. My bullish investment thesis was right on queue with the recent rally above $6, but the biggest risk to the bullish call of oversupply occurred during the quarter ended in May. Aphria is appealing down at $5, but investors have to watch the inventory equation with a sharp eye going forward.
Source: Aphria website
While Aphria technically beat FQ4 revenue estimates, the beat came entirely from the boost in low-margin distribution revenue in Germany. Net cannabis revenue actually declined sequentially to only C$53.0 million, though the mix was better with more recreational cannabis and less bulk sales. The total revenues of C$152.2 million were solid, but the market was expecting much more of the higher margin cannabis sales and hoping for higher EBITDA profits.
The concern here is that cannabis sales remain highly unpredictable. Based on brand, product, and quality, sales appear to shift from quarter to quarter. Consumer behavior has been very difficult to predict leading to excess inventories regularly being written off by sector participants.
Despite all the success and leading profit picture in the Canadian cannabis sector, Aphria only ended the year with an EBITDA profit of C$17.2 million. The company had guided to ~C$92 million for FY20 entering 2020 and as much as C$35 million to C$42 million until as recently as April when guidance was pulled.
Investors can definitely focus on the C$8.6 million EBITDA profits in FQ4, but the company only achieving 19% of the original target for FY20 reduces some of the confidence in the ability of management to execute.
Over Supply Fears
As Aphria completed the Aphria Diamond facility at the end of last year, the number one worry was the company aggressively over-producing cannabis in a path every other Canadian cannabis LP followed in 2019. The facility increased production capacity from 115K kg to 255K kg. The FQ4 results are eerily similar to the path to ruin taken by other Canadian cannabis companies.
For FQ4 ending in May, Aphria produced 52,243 kg of cannabis and only sold 12,557 kg. Not only did the company produce over 4x sales but also the overproduction levels followed the February quarter where Aphria produced over double the 14,014 kg sold. Even worse, kg equivalents sold in the quarter were down sequentially. The numbers have the company producing over 67K kg in excess of demand in the last year alone.
Source: Aphria FQ4’20 MD&A
Inventories are up to C$264.3 million ending in May, up from only C$91.5 million last FQ4 end. Management wasn’t very convincing on the earnings call that these levels of inventories are needed.
Analysts have Aphria generating minimal revenue bumps in the next few quarters questioning how the company could ever deliver sales needing these excess production levels.
The key investor takeaway is that Aphria is generally attractive trading at a market cap of only $1.4 billion. The cannabis company has a net cash position and solid EBITDA profits.
Unfortunately, management hasn’t made a convincing case for spending so much money on excess production. The stock is a tepid buy below $5 with the caveat that Aphria won’t see any upside if the company doesn’t control inventories better.
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.