Aphria (NYSE:APHA) stock reported strong numbers for the first quarter of 2020 and triggered a strong near-term rally. However, Aphria stock is still lower by 54% from 2019 highs. I further believe that APHA stock is unlikely to provide investors will any major upside trigger. Even if the downside is limited from current levels, it would be optimistic to assume that APHA stock is positioned for a breakout rally. Therefore, investors should remain on the sidelines.
APHA reported stellar top-line growth for its first quarter of 2020 with revenue increasing to $126.1 million as compared to $13.3 million in 1Q19. However, distribution revenue for 1Q20 was $95.3 million. The growth from its core cannabis business was much lower than the headline numbers suggest.
For 1Q20, the company’s revenue from cannabis products was $35.1 million as compared to 4Q19 revenue of $33.5 million. While I am looking at a quarter-on-quarter (QOQ) growth, it should be robust for a business at an initial growth stage. For Aphria, revenue from medicinal cannabis declined marginally on a QOQ basis. At the same time, revenue from recreational cannabis witnessed 7.9% growth on a QOQ basis.
The key point being, the core business of medicinal and recreational cannabis has yet to gain traction.
No Bullish Triggers for Medicinal Cannabis and Aphria Stock
I believe that medicinal cannabis growth will be relatively muted in the next few years. The company’s 1Q20 management discussion and analysis outlines the reason: “Clinical research studies may lead to conclusions that dispute or conflict with the company’s understanding and belief regarding the medical benefits.”
The company further states: “Research in Canada, the United States and internationally regarding the medical benefits, viability, safety, efficacy and dosing of cannabis or isolated cannabinoids (such as CBD and THC) remains in relatively early stages.”
This point is verified by a survey about medical cannabis among primary care providers. According to the survey results, “clinical trial data about how medical cannabis improves patient quality of life domains is desperately needed.”
Clearly, the need for clinical-based evidence is gaining importance. And it will take a few years before evidence-based medicines are introduced. This “knowledge gap” is likely to keep physicians cautious on advising cannabis-related medicines. The impact will be on top-line growth for the industry.
APHA Has Ample Financial Headroom
Growth in the medicinal and recreational cannabis industry might be slower than expected. However, Aphria has ample financial flexibility to see through a period of cash burn.
For 1Q20, APHA reported negative operating cash flows of $31 million. This implies an annualized cash burn of $120 million. For the same period, Aphria reported cash and equivalents of $450 million. This would cover for at least three-to-four years of cash burn.
Equity dilution and accelerated cash burn is a key concern among companies in the cannabis industry. Aphria is relatively well-positioned from that perspective.
I do believe that as R&D and marketing efforts accelerate, the company will need external funding. However, the company is well capitalized for the medium-term.
Aphria Stock Has Strong Competition
The addressable market for medicinal and recreational cannabis might be estimated in the range of $150 to $200 billion. However, it will be years before the cannabis products reach the potential markets.
From that perspective, the industry already has significant competition. Be it Canopy Growth (NYSE:CGC), Aurora Cannabis (NYSE:ACB) or Aphria, the growth strategy is similar. Companies are looking to expand on the higher margin recreational cannabis products.
Further, there is little to cheer about when companies are expanding their cannabis production capacity. The inventory of dried cannabis has been surging. Therefore, there is excess capacity at a time when adoption of cannabis products has been relatively slow.
Final Words on APHA Stock
It is unlikely that APHA stock will bounce back sharply soon even with 1Q20 results presenting a positive surprise for the markets.
I believe that the industry needs more time to grow, with regulatory headwinds being the key reason. Further, the time lag due to clinical research will impact growth potential and require higher R&D investment.
It is worth noting that medicinal cannabis market in the United States is expected to grow at a CAGR of 12.7% through 2025. It would be unrealistic to expect top-line growth for Aphria to sustain even close to current levels.
Given this outlook, I expect APHA stock to go sideways.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
