Aphria's (NYSE:APHA) latest earnings report released on Oct. 15, was a breath of fresh air in an otherwise bleak and disappointing marijuana sector. Not only did the pot grower manage to increase its top line substantially year over year in Q1 2020, but Aphria also recorded a net profit for the second quarter in a row, something few of the top-rated cannabis companies have managed to do.
However, it is worth pointing out that Aphria accomplished these feats in large part thanks to its international operations. In particular, Aphria's operations in Germany have been instrumental to the company's recent success. The pot grower completed the acquisition of CC Pharma -- a German medical cannabis distributor -- earlier this year. Revenue from CC Pharma accounted for about 74% of the company's net revenues during its latest reported quarter.
Aphria's operations in South America are also noteworthy. The company's LATAM acquisition landed it in a world of trouble because of allegations that it had overpaid for the deal in an effort by some of its executives to enrich themselves. But the company now boasts a presence in South America (it owns assets in Argentina, Brazil, and Columbia), a promising marijuana market. Recreational uses of pot are already legal in Uruguay and might soon become legal in Mexico.
Meanwhile, the company's operations in the Canadian market may have faded in the background a bit. This raises the following question: Just how strong are Aphria's domestic operations and what role will they play in the company's future?
Aphria has the tools to compete
There are many ways for cannabis companies to capture a notable share of the Canadian market, but arguably the two most important factors are production capacity and distribution channels. Aphria's standing in both categories rivals that of almost any of its peers.
First, the company boasts one of the highest output capacities in Canada. Aphria was recently granted a cultivation license by Health Canada for its 1.3 million-square-foot greenhouse facility in Ontario. This facility has a production capacity of 140,000 kilograms a year, bringing the company's total output capacity to 255,000 kilograms per year. Note that only about a dozen pot companies have managed to break the 100,000 kilograms-per-year mark. And while Aphria still trails both Aurora Cannabis and Canopy Growth in this particular area, that isn't much cause for alarm.
Second, Aphria has achieved another rare milestone in the Canadian cannabis market: The company landed supply agreements with every Canadian province. Other companies that are part of this exclusive club include OrganiGram Holdings, CannTrust Holdings, and, of course, Canopy. The ability to reach the entire Canadian population sets Aphria apart from many of its competitors, but perhaps the company's operations in Ontario -- the largest Canadian province by population -- are even more noteworthy. According to Aphria's interim CEO, Irwin Simon, the company holds a 12% share of the cannabis market in Ontario, up 4% sequentially.
During the first quarter of its current fiscal year, Aphria managed to increase its average selling cost per gram by 7% sequentially, while its revenue from cannabis produced grew by 4% sequentially. While these sequential movements don't seem particularly impressive, it is essential to put them in perspective: The Canadian cannabis market has been plagued by a series of issues, including a longer-than-expected wait time to receive licenses from Health Canada. Aphria's performance isn't that bad, all things considered.
Launch of the derivatives market
The derivative market, also known as Cannabis 2.0, recently launched in Canada, but derivative products probably won't be found on shelves until December. Still, this new development presents an important opportunity for cannabis companies. Derivative products often offer higher margins than their recreational counterparts. No surprise, then, that Aphria and its peers are gearing up to profit from this lucrative market.
According to Aphria CFO Carl Merton:
We think that dried flower remains a predominant share of the market, going forward. But the vapes category and the new derivative products start to take significant amount of market share fairly quickly. Our internal models are really based around 60% market share for dried cannabis, 20% to 30% for vapes, and the remainder being split between drinks, edibles, and the other new product formats.
Even taking into account the current health concerns surrounding vaping, this particular segment of the market could turn out to be one of the more profitable. And while Aphria will no doubt face severe competition in this segment, the company may be able to leverage its current position in the market to edge out or at least rival its peers.
Don't sleep on Aphria's domestic operations
The degree to which Aphria's international operations -- particularly its acquisition of CC Pharma -- have played a role in its recent successes can hardly be overstated. However, it would be a mistake to overlook the pot grower's footprints in its domestic market. Aphria is one of the top cannabis companies in Canada in terms of production capacity, is one of the few that holds supply agreements with every province, and is also looking to leverage its position in the market to profit from the launch of derivative product. For these reasons, Aphria will likely continue counting on its domestic operations to make a material impact on its top and bottom lines.