Profitability Will Make Aphria a Top-Tier Cannabis Stock

Aphria (APHA +0.00%), like most of its peers in the cannabis industry, faced both stock declines and business-related struggles in 2019. A massive supply glut has led to weak pricing. Moreover, a slow path to legalization outside of Canada has dampened much of the optimism. Furthermore, taxation and regulation have helped to keep the black market in business. The company saw less of a stock price decline than its peers. Still, Aphria stock has still fallen by more than 55% from its 52-week high. 

However, despite the massive declines, revenues across the industry continue their enormous growth. Though it missed forecasts, Aphria posted year-over-year revenue growth of more than 849% in the previous quarter. This and the company's profitability should position Aphria for long-term growth as weaker peers close their doors and the march toward legalization across the world continues.

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Aphria's position in Canada

Amid discussion of the top four cannabis companies--Canopy Growth, Aurora Cannabis, Cronos Group, and Tilray--Aphria receives less attention. However, Aphria is one of the few major cannabis firms yielding a profit. Moreover, it comes out ahead of its top-four peers on revenue.

Data Source: Company Filings

Much of this revenue comes from the company's production capacity. Analysts estimate that Aphria can now produce 255,000 kilograms of dried cannabis annually. This lags only Aurora Cannabis and Canopy Growth, who hold production capacity of 662,000 kilos and 500,000-550,000 kilos of capacity, respectively. Unlike most of its peers, Aphria has also signed a supply agreement with every Canadian province.

However, the buzz surrounding marijuana companies has led to a severe supply glut in Canada. In September 2019, retailers sold 12,922 kilograms of cannabis, well below the 64,151 kilograms of finished inventory and 316,515 kilograms of unfinished inventory. Worse, with marijuana only partially legal in other countries, exports only offer a limited outlet. This makes production capacity more of a liability than an asset for now. However, improving conditions could turn production into an asset again soon.

The growth of Aphria

The Canadian cannabis industry has seen slower-than-expected growth. Fortunately for Aphria, profitability, and expansion abroad have softened the impact. Wall Street forecasts earnings of seven Canadian cents per share for the current fiscal year, with 200% growth. Moreover, its CC Pharma acquisition accounted for 74% of the company's revenue in the previous quarter, driving most of the previously mentioned 849% year-over-year growth in revenue. In the German market, Aphria benefited from both high demand for medicinal cannabis (Aphria can only sell its medicinal cannabis there) and a supply shortage in that country.

Derivative cannabis products such as beverages, edibles, vapes became legal on October 17th. Still, markets have only benefited slowly. October 17th served as the day when companies could begin the 60-day approval process to sell derivative products. Hence, Aphria and its peers did not see any sales from derivatives until mid-December. Since Aphria's 3rd quarter of 2020 ends on February 28th, financials from those sales may not come out until April. 

The case for Aphria stock

In terms of valuation, Aphria has not been a typical marijuana stock. The current price places Aphria's price-to-sales multiple at only about 6.75. Even after significant price drops in 2019, Canopy Growth sells for around 27 times sales. Tilray's P/S ratio is about 11 despite falling more than 90% from its all-time high. Sales multiples could remain elevated for some time to come. Nonetheless, this drop may indicate that the days of triple-digit P/S ratios in the cannabis industry may have ended.

APHA PS Ratio data by YCharts

It could also present an opportunity for Aphria as some of the so-called "top tier" stocks face financial troubles. Repeated sales of stock and the resulting dilution illustrate these issues. Aphria diluted its shares by 381% over the last five years. While Aphria's dilution is well above average relative to most stocks, it still stands in stark contrast to Aurora Cannabis. Aurora diluted its shares by more than 956% over the same period. 

Aphria used its proceeds on acquisitions such as Germany-based CC Pharma. Aurora Cannabis made several acquisitions. They also became the world's largest producer by investing in facilities capable of at least 662,000 kg of production. This has hurt the company as the industry struggles with an oversupply of dried cannabis. Due to these losses and the dilution, Aurora Cannabis sells for $1.70 per share level as of the time of this writing, a drop of almost 87% from its all-time high. With losses projected until at least 2022, it may have to sell some of its production capacity to stay afloat.

Tilray, which once traded as high as $300 per share, also faces a grim fate. Now trading in the $16 per share range, it is down, it has fallen by almost 95% from the $300 per share high in 2018. A lack of profits or options to attract outside funding could take it much lower. 

Though Aphria isn't perfect, it at least earns a profit. Admittedly, investors may want to place an asterisk on these profits. The company raised debt in the previous quarter, and its "profit" in its most recent quarter came from non-operating income. However, forecasts point to profit increases, and the debt should help cover the operating shortfalls until the operations side of the company reports positive earnings.

Should you buy Aphria stock?

Profitability will give Aphria a long-term advantage as the funding struggles of its peers create an opportunity to gain market share. The pain across the marijuana industry has not left Aphria untouched. However, even with its profits coming from outside of its operations, it remains in better shape than some of the so-called "top tier" cannabis stocks. 

Yes, Aphria's production capacity has become temporarily unattractive as a supply glut persists. However, revenues should continue to register massive growth. Moreover, the Canadian government will likely make progress in some of the regulatory roadblocks that hampered the industry. With this, the market conditions that hurt Aphria stock in 2019 should help to send it higher in 2020.