Summary
Aphria has undergone a very tough 2018 due to self-inflicted corporate shenanigans. From Nuuvera insider dealings to the Latin American acquisition, Aphria seems like damaged goods now.
However, Aphria could prove itself by announcing a strong quarter but the downside risk could be equally severe if results disappoint.
We have come up with $40 million in revenue as a rough estimate based on management's guidance but there are several risks pointing to the downside as discussed in this article.
Aphria (APHA) will announce its fiscal 2019 second quarter results on January 11, 2019. The company has been embroiled in a series of events including the QCM/Hindenburg short attack and the recent hostile bid indication from Green Growth (OTCQB:GGBXF). Management has not published its promised line-by-line rebuttal to address the short report. However, many of Aphria's investors are hoping that the upcoming earnings could prove its worth. Despite all that, investors might not have the right expectation when it comes to Aphria's ability to generate revenue heading into legalization. We will analyze what Aphria reported last quarter and discuss expectations for this Friday.
Q2 F2019 Preview
Aphria will report results for its fiscal 2019 second quarter results for the period that ended on November 30, 2018. To have the right expectation heading into this quarter, we think it is important to review what happened last quarter. For Q1 F2017, Aphria reported revenue of $13.3 million which represents an increase of 11% from the prior quarter. During the last quarter, Aphria sold 1,778 kilograms of cannabis which is a 36% increase from the prior quarter. The reason why revenue grew less than volume is that the average selling price decreased 18% as the company had to sell more cannabis through wholesale which accounted for 312 kg or 18% of the whole volume. This will have profound implications for the upcoming quarter.
First of all, the upcoming quarter represents the three months between September to November 2018, which means that it will only capture 1.5 months of sales from legalization. Investors should adjust their expectations accordingly to account for the fractional quarter.
Secondly, investors should expect volume to increase substantially while average selling price to decrease by a large percentage as well. Management disclosed last quarter that the company received initial orders of over 5,000 kg which might serve as a good proxy for its initial revenue during the first month of legalization. The nature of the procurement process makes LPs' revenue quite volatile, including Aphria. Assuming 5,000 kg of cannabis is sold at the onset of the legal sales, Aphria would be looking at potential revenue of $25 million using a simplified wholesale price of $5.0 per gram.
Based on the initial orders placed by the above provincial bodies, the Company has secured purchase orders for over 5,000 kgs of gram equivalents cannabis and cannabis products - Q1 F2019 MD&A
Aphria also said it has signed supply deals with all Canadian provinces and Yukon and its annualized order would exceed 30,000 kg. While it is unclear how the initial 5,000 kg translates into the 30,000 kg annualized number, we think Aphria has achieved one of the largest initial orders among the Canadian LPs with its only rivals being Aurora (OTC:ACB) and Canopy (OTC:CGC).
Q2 F2019 Revenue
Assuming that Aphria's existing business continues to generate $13.3 million revenue in the coming quarter and it could generate an additional $25 million in revenue from recreational sales, we are looking at close to $40 million revenue for this quarter. However, it is important to note that there are a few embedded assumptions for the $40 million number:
No cannibalization from the existing medical market (Canopy and Aurora both reported softness in their medical segment before legalization).
The average selling price of $5.0 could prove to be conservative, however, Aphria will have to shoulder the federal excise tax and provincial taxes.
We assumed 50,000 kg of initial orders are all booked during the quarter, which might be too optimistic because Aphria might not be able to ship enough cannabis to meet demand based on media reports of widespread shortages across Canada.
Perhaps more importantly, given the lumpiness of the purchase order, Aphria's revenue potential for the entire year would only be $150 million assuming an average selling price of $5.0 per gram and 30,000 kg per management guidance. Of course, that was based on only the initial indication from provinces and things will change as the year progresses. Nevertheless, it is important and helpful for investors to get a sense of the revenue potential in order to put its valuation into perspective. Aphria currently has a market cap of $1.8 billion, which means that it has to generate much more than $150 million in order to sustain its market cap.
Besides revenue, we think investors will also be actively looking for an update on any commentary on the short report published by QCM/Hindenburg. Since the short report was released, Aphria has not provided the line-by-line rebuttal that it has promised to investors. The company is also facing a potential hostile bid from Green Growth, which will be another topic of interest. Lastly, it is worth noting that Aphria shares remain depressed since the short report was released.
The stock was trading at $10.51 before the short report was published and the current share price remains 20% below that. Although the stock has recovered most of its value since the short report, we think there are permanent damages to the Aphria brand. Investors will be looking for management commentary on any interest from potential acquirers as a sale of the whole company becomes a real possibility. We think there are very few Canadian companies that could acquire Aphria at its current valuation ($1.9 billion market cap and 30x revenue) which remains high after the 20% drop. There might be other U.S. cannabis companies looking at Aphria other than Green Growth.
Conclusion
This upcoming quarter will become one of the most crucial moments for Aphria due to its recent struggles. If the company disappoints, we think its remaining investors will have one less reason to hold onto their stocks. However, Aphria also has the opportunity to prove its worth by delivering a strong performance on the back of a struggling quarter it just reported a few months ago. We believe Aphria's Canadian assets hold significant value and it holds one of the best market positions in the Canadian market. Investors will also be looking for an update on the LATAM short report rebuttal and potential changes to management and corporate governance.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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