Company Overview
Aphria Inc. (OTCQB: APHQF) is a Canadian company that produces, supplies, and sells medical cannabis. Pure Nature Wellness Inc. (PNW), a wholly-owned subsidiary of the company, is licensed to produce and sell medical cannabis under the provisions of the Access to Cannabis for Medical Purposes Regulations (ACMPR). The company’s greenhouse operations are located in Leamington, Ontario.
The company produces medical cannabis for both retail and wholesale channels. Retail sales occur primarily through Aphria’s online store and telephone orders. Wholesale shipments are sold to other ACMPR-licensed producers.
Production Capabilities
The company’s medical cannabis products consist of dried cannabis and cannabis oil, in a variety of indica, sativa, and hybrid strains. Aphria’s existing ACMPR license allows for 3,600 kilograms of dried cannabis for wholesale, 2,500 kilograms of dried cannabis for retail sales, and 450 kilograms of cannabis oil. Aphria’s gross margin on retail sales is approximately 70 percent. Margins on wholesale shipments are approximately 50 percent.
As a greenhouse producer, Aphria’s production costs are among the lowest in the industry. Below is the company’s 2016 quarterly production cost per gram compared to competitor data pulled from public filings in March, April, or May 2016.
Source: Company Reports
The all-in cost per gram is calculated as cost of sales (excluding fair value adjustments of biological assets) divided by grams sold. Cash cost is the average cost of sales per gram less amortization. Aphria’s lower costs are driven by fertilizer and electrical savings. The company’s fertilizer cost is C$0.005 / L (as compared to competitor fertilizer costs of C$0.22 / L) and electrical cost is C$5.50 / square foot (as compared to C$65.00 / square foot for indoor growers).
Aphria is in the midst of a multi-phase expansion program. Upon completion of Part II, the company expects that annual production capacity will reach 5,500 kilograms of dried cannabis and 9,000 litres of cannabis oil.
Source: Company Presentation
Market Overview
According to data from Arcview Market Research, North American consumers spent $6.7 billion on legal cannabis products in 2016, a 34 percent increase from the prior year. By 2020, this figure could grow to $18 billion.
The most recent available data collected by Health Canada for Canadian medical cannabis consumption is summarized in the table below:
Source: Health Canada
The Canadian government recently introduced Bill C-45 to fully legalize cannabis. Although the exact timeline is uncertain, many expect legalization to occur within the first half of 2018. Medical sales by licensed producers are already legal, but it remains unclear exactly how recreational sales will be regulated.
The proposed legislation does state that licensed producers under the ACMPR will become licensed producers under the new Cannabis Act. Therefore, existing producers with established operations and access to financing, such as Aphria, Organigram, and Canopy Growth, would be well-positioned to capitalize on new market opportunities. However, if the government adopts a free-market approach to the sale and distribution of cannabis, competition among existing producers and new entrants could increase significantly.
Recent Developments
- On April 13, 2017, Aphria reported its fifth consecutive quarter of profitability. The company also announced that it was increasing its production capacity targets for its expansion program, to 8,000 kilograms for Part II, 22,000 kilograms for Part III, and 75,000 kilograms for Part IV.
- On April 19, 2017, Aphria announced a joint deal with Tetra Bio-Pharma for the distribution of dried medical cannabis in Quebec and the Maritime provinces. Based on the success of the arrangement, Tetra and Aphria may expand into other provinces. Commercial operations are expected to begin in the summer of 2017, with revenue being recognized shortly thereafter. Tetra and Aphria have already collaborated on the development of PPP001, a prescription drug using dried cannabis.
- On April 20, 2017, the company announced that it had raised C$100 million in financing, consisting of C$75 million of equity on behalf of a syndicate of underwriters lead by Clarus Securities Inc. and a C$25 million five-year term loan from WFCU Credit Union. The loan bears interest at a rate of 3.95 percent and follows a 15-year amortization schedule. The net proceeds will be allocated equally between Part IV of the company’s expansion plan and working capital needs.
Third-Quarter Earnings Review
Revenue for the quarter ended February 28, 2017, totaled C$5.1 million, a 90 percent increase from the same period one year ago. Gross margin declined slightly from 73.4 percent to 70.0 percent, but was still in line with the company’s target for retail sales. Earnings before interest, taxes, depreciation, and amortization (EBITDA) in the third quarter of 2017 increased to C$1.0 million, more than double the C$0.4 million reported in the third quarter of 2016. As noted above, this was Aphria’s fifth consecutive profitable quarter.
The company did report a C$0.44 increase in the all-in production cost per gram, climbing from C$1.79 in the second quarter of 2017 to $2.23. Increasing production costs were primarily attributable to abnormal weather conditions at the Leamington facility and costs incurred due to the capacity expansion program.
Aphria’s balance sheet remains strong, with C$84.4 million in cash and equivalents and a working capital balance of C$123.1 million. These figures do not account for the recently announced capital raise.
Stock Influences
- Changes in the company’s cannabis production capacity;
- Changes to the company’s production costs;
- Significant new agreements with customers, suppliers, and/or government agencies; and
- Changes to the company’s capital structure.
Risk Factors
- The company’s greenhouse operations are subject to weather risks;
- The company’s shares trade at a substantial premium to both earnings and sales; and
- Changes in legislation could impact the competitive marketplace.
Stock Performance
As of April 21, 2017, shares of Aphria closed at $4.96, yielding a market capitalization of $619 million. As shown above the share price has followed a generally positive trend in the past 12 months, gaining more than 270 percent. Over the same period, Aphria’s annualized daily volatility was 70 percent. Daily trading volume in the past year ranged from 10,000 to 200,000 shares with an average of 113,000. The last month has been much more active, with an average daily volume of 317,000 shares and nine trading days with volumes greater than 450,000 shares.
Summary
Aphria’s low production costs and healthy margins have helped the company achieve several consecutive profitable quarters. Furthermore, the company has a strong balance sheet, and it recently secured additional financing to expand its operations in order to meet growing demand. The tabled legislation from the Canadian government could provide a significant revenue boost as early as 2018, but may lead to additional competitive pressures from new entrants.
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