In a little over two months, the date Canadian cannabis enthusiasts and investors have long been waiting for will finally arrive. On October 17, recreational marijuana will officially go on sale in our neighbor to the north, following passage of the Cannabis Act in June. Canada will become the first industrialized country in the world to allow adults to legally purchase marijuana.

Though estimates vary wildly since no country the size of Canada has ever given adult-use weed the green light before, most pundits predict in the neighborhood of $5 billion in added annual sales once the industry is operating at full capacity. Between domestic medical and recreational demand, and the ability of most major growers to export medical cannabis to overseas markets where the substance has been legalized in some capacity, the legal cannabis industry is viewed by some as a surefire growth industry.

A tipped over bottle filled with dried cannabis, lying atop a messy pile of cash bills.

Image source: Getty Images.

Aphria's fourth-quarter and full-year report may look like business as usual...

However, growth doesn't come without its occasional speed bumps, as Aphria's (NASDAQOTH:APHQF) shareholders found out this past week.

On Wednesday, August 1, the Ontario-based grower, which currently sits third in the pecking order in terms of forecasted peak annual production at 255,000 kilograms of cannabis-equivalent output, delivered genuinely subpar results.

If you were purely focused on the headline numbers, you'd have figured it was business as usual. Sales for the fourth quarter and full year improved 17% and 81%, respectively, with the company turning in a full-year profit of 0.18 Canadian dollars per share, compared to CA$0.04 per share in net income in the previous fiscal year. 

In fact, the quarterly press release rattled off no shortage of quarterly highlights, including:

  • An improvement in cash costs to produce dried cannabis per gram to CA$0.95, down CA$0.01 from the sequential quarter.
  • The securing of a distribution partnership with Southern Glazer, one of North America's largest liquid distributors.
  • Signed memorandums of understanding with six provinces to supply cannabis.
  • Reported its 11th consecutive quarter of positive EBITDA (earnings before interest, taxes, depreciation, and amortization) from its domestic medical cannabis operations.

But if you did any digging whatsoever into the company's quarterly or full-year results, or, worse yet, if you read the commentary from CEO Vic Neufeld, you'd realize that this was actually a very poor report. According to Neufeld:

We are excited and ready to hit the ground running on the first day of legal adult-use. It won't be without its challenges, but we have a plan and the team in place to get it done.

This admission that challenges lie ahead is a first for a major pot stock, and it lends credence to the numerous ways Aphria disappointed in the fourth quarter.

A frustrated mature woman with her hand on her forehead while sitting in front of her laptop.

Image source: Getty Images.

...but this was a genuinely bad report

To begin with, take the company's 11th straight quarter of positive EBITDA with a grain of salt. For whatever reason, management decided to break out the company's international operations beginning in Q4 2018 from its medical cannabis operations. So yes, while its existing medical operations produced CA$2.2 million in EBITDA, "extending the streak," Aphria International generated negative CA$2.8 million in EBITDA. Nice try, Aphria, but there's no masking the higher costs associated with expansion into new markets.

Another reason to be less impressed is that while cash costs per gram produced fell by CA$0.01 to CA$0.95, all-in costs of producing dried cannabis per gram actually rose modestly to CA$1.60 from CA$1.56 in the sequential third quarter. Though Aphria has a very valid reason for this increase in costs -- the hiring of new workers in advance of the legalization of recreational weed in Canada -- it nonetheless confirms that higher costs are going to weigh on EBITDA and (likely) profitability in the near future.

Speaking of profits, don't be enamored with Aphria's full-year per-share profit of CA$0.18. The company recorded substantial gains on long-term investments, from asset sales, and on the fair value adjustment of biological assets. If you strip out these factors, toss all fair-market adjustments out, and strictly look at Aphria in terms of gross profit-versus-operating expenses, the company's expenses came really close to doubling its gross profit. Again, not impressive.

Even the company's product diversity has left a lot to be desired. Whereas I've praised Aphria in the past for its focus on cannabis alternatives, the company's percentage of sales tied to oils fell by 390 basis points to 29.2% from the sequential quarter. This is noteworthy given that alternative products like oils have much higher price points, better margins, and are less prone to commoditization, relative to dried cannabis.

A magnifying glass held over a balance sheet.

Image source: Getty Images.

Dilution remains a serious concern

Then, there's the icing on the cake, as with all marijuana stocks: share-based dilution.

Prior to the passage of the Cannabis Act, marijuana stocks like Aphria had one primary means of raising capital: bought-deal offerings. A bought-deal offering involves the sale of common stock, convertible debentures, stock options, and/or warrants to an investor or group of investors in order to raise capital. Since pot stocks weren't generating enough in operating cash flow to expand their capacity, and they lacked access to basic banking services, bought-deal offerings filled this role of capital-raising.

What they also did was balloon the outstanding share counts of publicly traded marijuana stocks. Based on the company's quarterly filing with SEDAR (the Canada regulatory agency that acts like the Securities and Exchange Commission), it ended the year with nearly 166 million weighted diluted shares outstanding, but it had a balance of 210.2 million shares of May 31, based on its share issuances, options, and warrants breakdown. That's triple the 70.1 million shares it had outstanding at the end of fiscal 2016. 

Even with better access to capital following the legalization of marijuana in Canada, it's not out of the question that dilution will continue to wreak havoc on Aphria -- and marijuana stocks in general.

In sum, this wasn't a banner quarter for Aphria, and it may speak volumes about the grim reality marijuana stock investors could soon face. Namely, that profits won't be as robust as first expected.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.