Cannabis stocks have plenty of challenges including trying to generate positive cash flow and struggling to break even.
Cash is a scarce resource for many companies in the sector, one that management teams shouldn't use unless it's going to result in growth or somehow improve their financials. That's why what cannabis producer Aphria (APHA) said on its most recent earnings call was all the more puzzling.
Could Aphria issue a dividend in the future?
As surprising as it sounds, the company's CFO Carl Merton mentioned the possibility of the cannabis producer distributing a dividend to its shareholders in light of its strong results. Aphria has recorded a positive adjusted earnings before interest taxes depreciation and amortization (EBITDA) for three straight quarters, and the company doesn't plan on that streak stopping anytime soon.
Not only is Merton counting on those strong results to drive the company's future growth, but he also mentioned "being in the position to provide an annual return to our shareholders through dividends." While there's no timeline as to when that might happen, it's a remarkable statement to make given the challenges many cannabis companies have had with respect to breaking even. Investors typically expect a dividend in a mature sector where profits are consistent, not in an industry experiencing high growth and rising costs.
Why it's not a good idea
It's certainly noble of Aphria to want to pay its shareholders a dividend. But given the challenges in the industry, such as the health concerns surrounding vaping products, it's just not a safe strategy.
Once a company starts issuing a dividend, investors come to expect it even though a company is under no obligation to continue paying it. If Aphria were to begin making dividend payments and then a problem arose where it needed to cut or eliminate them, the move would adversely affect its share price. After all, a company doesn't cut its dividend when things are going well.
Perhaps the most important reason for a cannabis company not to pay a dividend is because it diverts cash at a time when it's most opportune to have plenty of it on hand. Cannabis stocks, including Aphria, have fallen heavily over the past six months. The Horizons Marijuana Life Sciences ETF is down 40% during that time while shares of HEXO have fallen 70%, making Aphria's 11% decline look very impressive.
As a result, valuations in the cannabis industry are the lowest they've ever been. With sufficient cash on hand, Aphria could take over a competitor and instantly improve its growth potential in one big move. That would add a lot more value for investors than a dividend would. While the company could make room for both growth and dividends, growth is what has made the sector what is it today and it's what investors want the company to focus on.
Should investors ditch a pot stock that pays dividends?
Offering a dividend can sometimes do more harm than good. If a cannabis company were to issue dividends so early in the industry's growth, it could be a cause for concern for investors that perhaps the company has run out of ideas as to how to grow the business.
Investors who want dividend income have plenty of stocks from other industries to choose from. When stock prices in the cannabis industry are plummeting, a 1% or even a 5% dividend isn't going to offer much of a reprieve for investors who have lost large chunks of their investments. Focusing on a new growth initiative, however, could help those stocks turn things around.
Aphria's talk of dividends may be years away from being a reality, but it's an important reminder for investors on why it's far too early for cannabis companies to be paying out any profits back out to shareholders just yet.