When it comes to the fastest-growing industries in North America right now, you can rest assured that legal cannabis is certainly in the mix. ArcView, one of the leading cannabis research firms, suggests that the North American legal weed market could grow by 26% annually through 2021, leading to almost $22 billion in annual sales. This type of growth is a big reason investors have flocked to marijuana stocks and pushed the value of these stocks through the roof.
But there's a pretty big difference between the countries that make up the North American market. In the U.S., marijuana businesses have gone on the defensive following Attorney Jeff Sessions' rescinding of the Cole memo, which was a loose set of rules that states agreed to abide by to keep the federal government off their backs. These rules included keeping adolescents away from pot, and ensuring that cannabis grown within a legal state stayed in that state.
Meanwhile, our neighbors north of the border are seeing incredible growth. Canada legalized medicinal cannabis all the way back in 2001, and the oversight of Health Canada has kept supply from getting out of hand. More recently, Canada has been debating legislation designed to legalize recreational pot by July. With progressives firmly in control of parliament, and a tax-sharing deal reached between the federal government and Canada's 13 provinces, recreational legalization by summer looks likely.
Long story short, Canada's has created the perfect growing environment for marijuana stocks and growers -- and Aphria (NASDAQOTH: APHQF) has certainly been taking advantage.
Five things to love about Aphria's latest operating results
Two weeks ago, in somewhat under-the-radar fashion, Aphria reported its second-quarter results through SEDAR, Canada's online filing depository. There were, in particular, five things that marijuana bulls are absolutely going to love about this report. However, there was also one aspect that stood out as a bit worrisome. Let's dig in.
1. 63% YoY sales growth
To begin with, shareholders should be pleased with Aphria's solid increase in year-over-year sales of 63% to $6.81 million. This sales figure came on the heels of the sale of 1,237 kilograms, or kilogram equivalents, such as oils, during Q2 2018, up by 45% since the sequential first quarter. Aphria attributed this increase to growth in medical patient demand, as well as higher average selling prices for dried cannabis, which is a good sign for future demand.
2. Ninth straight quarter of positive EBITDA
But what shareholders should really love is that Aphria reported its ninth consecutive quarter of positive EBITDA (earnings before interest, taxes, depreciation, and amortization). Though Aphria isn't exactly generating huge profits at the moment, its management team has made a genuine effort to remain profitable. It's one of only two cannabis stocks, along with MedReleaf, to remain profitable on a full-year basis in each of the past two years.
3. Four-phase expansion on track and budget
Aphria's pride and joy is its four-phase expansion project designed to increase its growing capacity to 1 million square feet. In doing so, the company should be able to produce 100,000 kilograms of dried cannabis a year. Aphria noted in its operating results that its four-phase expansion remains on track and budget, with phase 3 (roughly 200,00 square feet) expected to be completed in late May 2018, and the remainder of the project slated for completion in late January 2019.
4. $137.6 million in cash, cash equivalents, and marketable securities
Expanding organically isn't cheap, so it's probably a good thing that Aphria has a lot of cash, cash equivalents, and marketable securities in its back pocket. It ended the fiscal second quarter (Nov. 30, 2017) with $137.6 million in cash, cash equivalents, and marketable securities, meaning its expansion projects are fully funded with cash to spare. Plus, it added another $87.2 million through a bought-deal financing subsequent to the end of the quarter, pushing its combined cash and securities well over $220 million.
5. Production capacity raised to 220,000 kilograms
Aphria also used its earnings press release to double down on news from just a few days prior that it had entered into a strategic relationship with Double Diamond Farms to provide an additional 120,000 kilograms of annual production in 2019. This deal was made because it allows Aphria to more than double its production a year quicker than developing its own 100-acre property. The 220,000 kilograms of production will place it near the top of the pack among individual growers in 2019.
This is a bit worrisome
However, I'd be remiss if I didn't also point out that the company's costs to produce cannabis soared during the quarter. As noted in the release:
During the quarter, our "all-in" costs of sales of dried cannabis per gram temporarily increased from [CA]$1.61 to [CA]$2.13. In an effort to bring an increased supply of cannabis to its patients as soon as possible after obtaining Health Canada approval of its Part II expansion, the company transferred less than ideal aged vegetative plants into the expansion upon receiving approval. The plants transferred were older than we traditionally transfer, as we dealt with a longer than expected approval process. The impact of transferring older plants was a decrease in yield, which spread our actual costs across lower harvest yields and resulted in a significant amount of unabsorbed overhead that was expensed in the quarter.
Although Aphria still maintains one of the lowest production costs in the industry, and its management team has put profits ahead of reckless spending, investors shouldn't overlook this warning sign that demonstrates the role approvals and licensing could play in the legal cannabis space. Even if Aphria is able to stay on budget and track with its own grow facilities, there are no certainties that the Canadian federal government or Health Canada, the regulatory body that oversees the medical industry, sticks to any particular timeframe.
Considering Aphria's stock has increased by more than 2,000% over the trailing two-year period, it might be prudent to allow the company's bottom line to play catch-up before you consider dipping your toes in the water.