Aphria (NYSE:APHA) is trading like a winner in the cannabis space while the hard, cold reality is far from that. The company is losing money and cash. Moreover, the CEO is making huge promises about revenue that are hard to reconcile. So why is Aphria trading at such a huge valuation — over $1.3 billion (U.S.) in market value?
For example, as measured on an operating cash flow basis, the company lost CAD 30.8 million in the August quarter. After deducting CAD 39.3 million in capital expenditures, Aphria’s free cash flow was negative CAD 70 million.
Aphria’s Financial Position Is Failing, Despite What Management Says
Moreover, its cash balance is deteriorating. Its cash balance fell from CAD 550.7 million to CAD 449.2 million. That is a drop of over CAD 101 million in one quarter. That is clearly not sustainable.
For example, that rate of loss implies that Aphria could come close to running out of money within the next year. A run rate of negative CAD 404 million in free cash flow could deplete cash reserves down to just CAD 144 million.
In addition, this is worse than last year. For the year ending May 31, 2019, Aphria had free cash flow losses of 262 million CAD. That is worse than the annual run rate for the latest quarter.
That is a lot bleaker financial perspective than what you hear from management. For example, management reported great news on page 26 of their Q1 2020 Management Discussion and Analysis document. It says they produced “adjusted EBITDA from cannabis operations” of 1.3 million CAD.
Wow. That sounds good. But it won’t cover the spending on items like interest, working capital needs, capital expenditures and taxes. The cash flow after those items was negative, as we have seen.
Aphria Convertible Debentures Are Completely Out-of-the-Money
Moreover, Aphria’s convertible debentures of CAD 450 million in convertibles are far from their conversion value. In April 2019 raised 350 million USD (CAD 470 million) in 5.25% convertible debentures, payable in five years.
But they can also be converted by the convertible holders into shares of common stock. According to note 20 in the FY 2019 annual report, the conversion price is CAD 9.38 per share. But APHA trades on the Toronto Stock Exchange (TSX:APHA) at a much lower price of CAD 6.75 per share. Aphria stock is CAD 2.63 per share out-of-the-money, or 28%, for the owners of the convertibles.
So Aphria is going to be stuck paying that 5.25% interest rate for the foreseeable future. The interest costs Aphria CAD 5.3 million per quarter and over CAD 21 million per year in cold hard cash. In addition, Aphria will also have to pay all that money back in four and a half years. Unless the Canadian stock price rises above CAD 9.81 per share, that obligation will stay on Aphria’s books.
Aphria Revenue Prospects and Forecasts Seem Outlandish
Aphria’s Oct. 15 press release for the August quarter included “guidance” that in the fiscal year ending May net revenue will be between CAD 650 million and CAD 700 million. But net revenue was only CAD 126 million this quarter.
That implies that revenue will increase CAD 549 million over the next three quarters, or CAD 183 million per quarter. That represents growth of 45% each quarter over this past quarter.
The problem with this forecast is that Aphria’s production is rising much faster than revenue. This is resulting in huge increases in inventory. In the past quarter alone, inventory grew 23% to CAD 113 million. But total net revenue was about flat compared to the prior quarter.
So the company is producing more cannabis, but so far there has not been sequential growth in revenue. That does not bode well for a dramatic increase in revenue guidance in the next three quarters.
Forgive me for being a skeptic, but I don’t believe the management story just yet on revenue guidance. If Aphria was running a truly profitable operation I might have more faith.
What Should Investors Do?
The quarter ending Nov. 30 is already over. It will be worth your time to wait for the numbers. Check to see if the company has reached cash flow profitability when earnings are released next month.
And I would also wait to see if the company’s revenue growth is still on a path to achieve what management indicated in Q1. There will likely be a chance to buy Aphria at a better price.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers a two-week free trial.
