Canadian Cannabis Earnings Rundown (Q4 2018)

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Includes: ACB, APHA, CGC, CRON, CTST, HEXO, MEDIF, MO, OGRMF, SPRWF, STZ, TGODF, TLRY, VFF, VVCIF
by: Cornerstone Investments
Summary

Canadian cannabis companies reported 2018 Q4 results which showed decent growth from most of the top companies.

However, we think early 2019 is going to present challenges as LPs face inventory shortages and continued logistical and distribution issues.

We think cannabis investors need to maintain a large exposure to the U.S. market given its more favorable growth outlook and regulatory framework compared to Canada.

Welcome to our Cannabis Earnings series where we break down the latest earnings to help you focus on the most important topics.

Introduction

All of the top Canadian cannabis companies have reported their earnings. We think it is crucial for investors to assess relative performances of the individual stocks in order to maintain a current understanding of the market positioning and progress within the Canadian market. The past quarter (calendar 2018 Q4) was a crucial one as it provided the first glimpse into post-legalization recreational sales for the first time. Not all companies lived up to their high expectations which resulted in some large share price movements.

Who Had the Best Earnings?

To answer this question, we think it is important to realize that most cannabis companies in Canada are still unprofitable. Despite the high expectations that have built up before the legalization, we think most cannabis companies remain at least a few quarters away from reaching profitability based on the latest numbers we've seen. Canopy (CGC) took the crown as it reported the highest revenue of any companies last quarter. However, we think revenue growth could slow down even for Canopy in 1H 2019 because Q4 included sales from inventories that have built up prior to legalization. LPs are likely going to have difficulties ramping up production to replenish inventories based on the latest updates we saw from a number of producers. Aurora (ACB) also reported a strong quarter revenue-wise as it clinched the second spot. Village Farms (VFF) has been on fire in the stock market but its revenue of $39 million came entirely from its vegetable produce business as its cannabis JV is not consolidated and produced negligible revenue in Q4 nevertheless. Aphria (APHA) and Tilray (TLRY) also reported large sales in the last quarter. Notably, MediPharm (otcqb:MEDIF) also reported one of the highest revenues last quarter as it began commercial sales after receiving its sale license only in November 2018.

(Source: Public Filings)

Statistics Canada had released retail recreational sales for 2018 Q4 which totaled $152 million. Using the reported sales from the top LPs, we have estimated the following recreational market shares. Canopy is the clear leader holding almost half of the whole market, followed by Aurora with 14% market share. Notably, Cronos (CRON) had only 1% of the market which indicates how poorly the company is positioned within the Canadian recreational market. CannTrust (CTST) also disappointed the market with its slow beginning in the recreational market despite high hopes. When CannTrust reported its 2018 Q4 results, the stock dropped 20% and continues to underperform in the recent days as investors reassess their growth outlook for the company that is struggling to scale up fast enough.

Canopy remains the largest cannabis company in Canada, in fact, in the world as well given its $20 billion market cap. The notable players are TGOD (otcqx:TGODF) which have reported zero revenue from its Canadian cannabis business despite having a $1 billion market cap. Village Farms has soared to #10 but it too has not reported any significant sales from cannabis.

(Source: Public Filings)

Companies remain well-capitalized for the most part after a few years of supportive financing markets. Canopy and Cronos hold billions of cash from their respective investments from Constellation (STZ) and Altria (MO). Others have frequently issued convertible securities as a way to raise capital while delaying dilution such as Tilray and Aurora. VIVO (otcqb:VVCIF) stood out as it turns out that the company has been hoarding a cash balance that is close to $100 million at this point. Supreme (otcqx:SPRWF) also had $92 million of cash due to previous financing rounds. We don't think these mid-cap companies will require a lot of ongoing capital investments which means that they are likely well-capitalized for the next few years.

(Source: Public Filings)

Looking Ahead

The Canadian cannabis stocks have had a fabulous start to 2019 as most stocks rallied after a tough finish in 2018. As the chart below shows, Tilray is the only stock that has fallen in 2019 so far. The biggest gainers this year included OrganiGram (otcqx:OGRMF), Aurora, and HEXO (HEXO). While the 2018 Q4 earnings season has finished and we have not seen too much reaction out of the stock market, besides CannTrust's disastrous earnings day, we think next quarter could be very different.

(Source: Bloomberg)

Heading into 2019 Q1 earnings season, we think there are disproportionately high risks skewed to the downside. We think 2018 Q4 included several one-time factors that could have inflated the reported numbers including a large release of inventories that LPs have accumulated over the previous quarters, in anticipation of legalization. Once LPs dumped all their stored products, we think very few of them are currently capable of replenishing their inventories sufficiently based on our knowledge and commentaries in the market. Most LPs are still ramping up their facilities and logistical issues are still major sticking points in the overall supply chain. We don't expect these issues to be resolved until later in 2019. Furthermore, Statistics Canada have released January recreational sales which actually declined from December. This is a bad sign for LPs indicating that the market has failed to expand its customer base and some of the initial hype and novelty factors are starting to wear out.

(Source: Statistics Canada)

In summary, despite an overall decent 2018 Q4 from Canadian cannabis companies, we think the first few quarters of 2019 are shaping up to become a lot more challenging based on early indications. Overall industry sales have declined in January and companies are likely having fewer products to sell after it depletes old inventories built up prior to legalization. We think investors should position themselves defensively heading into the earnings season and we think it is important to allocate a large portion of your cannabis portfolio to the U.S. industry. We think the U.S. cannabis market is many times the size of Canada and benefits from less government regulation and more vibrant retail environment and represents a crucial part of the global cannabis market.

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.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.