Aphria's Fourth Quarter And Expansion In Marijuana Capacity

Summary

• Aphria's fourth quarter disappointed me in terms of net income, but the loss came from investment expense vs. poor sales.
• In fact, the company grew revenue exponentially, with strong improvements in gross margins.
• With ever shrinking costs to produce, Aphria is setting itself up well with rapidly expanding production capacity.
• The outcomes of these efforts rests with the decisions of the Canadian government; and to a lesser extent US moves on state regulation of cannabis.

(Aphria’s financial results are in Canadian dollars)

First of all, yes. I am disappointed by the net loss for Aphria’s (APHQF) fiscal fourth quarter. That said, there’s a lot more good than bad occurring here. The company put a lot of investment into expanding its production capabilities and growing its US subsidiaries; which undermined the impressive revenue growth the company has achieved. I took a position in Aphria back around the beginning of the year; and remain long on the stock. It has until this most recent quarter, been a profitable business with expanding sales.

The latest financials

Aphria’s revenues increased by 106% (year over year) to over $5.7 million for the three months ended March 31^st 2017. On a 12 month basis, the company has grown revenues by 142% to more than $20 million. The company is living up to its claims as the “low cost” producer in the Medical Marijuana industry with increasing margins.

Gross Margins increased to 85.7%; an 11.2% increase from the year prior. These margins are coming from the company’s stringent focus on improving costs at every chance. Aphria increased its production to 738.3 kilograms; a 13.11% increase from the third quarter. In the process, they drove down “all in” costs per gram to $1.67 vs. $2.23 last quarter. That’s a 25% improvement. I would caution those so focused on net income to look at the big picture here. The $2.59 million quarterly loss is nothing compared to the strong growth in EBITDA, expansion of investment, and full fiscal year profitability.

I’ve spoken before about Aphria’s vested interests in US subsidiaries. Their $25 million investment into DFMMJ allowed the subsidiary to purchase most of the assets of Chestnut Hill Tree Farm LLC. Chestnut Hill has one of the limited growing licenses for cannabis in the state of Florida. This strategically sets up Aphria to benefit from royalties, and ownership in the American medical marijuana scene. I like this investment as it focuses on the legal side of things versus the murky waters of state legalized enterprise.

It seems more than anything that the Canadian Marijuana players are in a race for production scale. With the impending Canadian discussion on legal weed, everybody wants to be ready to get as much of that action as possible. Assuming all goes to plan on that front, Aphria should have more than enough product to be a part of the equation. CEO Vic Neufeld has stated that by the “proposed” legalization day of July 1, 2018, Aphria will be producing 30,000 kilograms annually; well above the demand levels for Medical Marijuana. Bear in mind, this is contingent on a number of things. With the company’s current expansion, they’re looking at around 9,000 kilograms of production capacity. That’s a big step from doing under 800 kilograms a quarter like they’re doing now. To give you an idea of the potential revenue stream, analysts covering the company have scoped Aphria’s total revenue potential (at the end of their expansionary plans) at $500 million a year.

The biggest things that I’ll be watching going forward are government developments. A large part of Aphria’s continued success is market share. I want to know specifically how the Canadian government will operate in regards to licensing. If it is highly regulated with the majority of production being allocated to current Medical producers, I’ll double or even triple my position in Aphria for the long term. If however, licensing gets too entangled in the debate process and the number of licensed producers increases too high, I worry that Aphria’s expansion efforts could be thwarted. Short term, companies like Aphria or Canopy Growth (TWMJF) have a big head start on fledgling producers due to their production abilities. Over a decade’s time, I worry that their advantage could be lost to competition.

The prospect of more players in the game is the reason I favor Aphria over Canopy. Aphria’s low cost structure gives them better maneuverability in the marketplace, and could allow them to leverage their position to beat out competition. I remain long on the stock.

Additional disclosure: Aphria Inc. pays Seeking Alpha a fee to participate in its Corporate Visibility program. This article was submitted independently by David Butler and selected by Seeking Alpha's editors for publication. No fee was paid for its publication.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long APHQF. 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.