Cannabis investors are hoping that 2020 will bring more clarity to marijuana stocks. After rising to record high levels in 2018, cannabis stock prices went down in a puff of smoke. One of the primary problems for cannabis stocks was a lack of profitability. Investors saw that making marijuana legal was only part of the battle. Canadian regulators have been slow to approve retail store licenses, creating a supply-demand imbalance.
With that said, Aphria (NYSE:APHA) stock has stood out for good reasons. Aphria has shown a profit where other cannabis stocks have failed. In 2019, APHA stock price fell “only” 17%. In context, the Horizons Marijuana Life Sciences ETF (OTCMKTS:HMLSF) dropped 39% for the year.
The question that many investors have is whether or not Aphria can generate actual sales that will help justify the company’s 2020 price targets.
Balance Sheet Sheds Suspicion on Those Positive Earnings
Aphria has turned a profit in its last two quarters. However, a closer look at the company’s balance sheet shows that the profit was due to a surge in non-operating income. The problem with non-operating income is that it can be a fickle beast. And without the non-operating income, Aphria would not be profitable.
Another problem for Aphria is the way they estimate the value of their crops on a quarterly basis. Additionally, APHA must estimate the projected cost to sell those goods. The result is a positive fair-value adjustment that doesn’t reflect how well (or in this case poorly) the actual performance of the company’s business was. Mark Hake took a much closer look at Aphria’s balance sheet and came to a bearish conclusion.
Now to be fair, this is not an issue that is unique to Aphria. The International Financial Reporting Standards for Canadian stocks sets the standard. However, the takeaway is that Aphria would not be profitable on an operating basis if those costs are stripped away.
Will APHA Be a Victim of Its Own Forecasts?
The other problem for APHA is that they have forecasted strong earnings. In its most recent earnings call, Aphria said it was expecting net revenue for fiscal 2020 of between 650 million CAD and 750 million CAD. The quarter that ended was Aphria’s first quarter of the 2020 fiscal year. With net revenue of approximately 126 million CAD, the company was less than 20% towards the low end of that forecast.
So, what do analysts project for the current quarter? The good news is that the consensus estimate is for revenue of 130 million CAD. The bad news is that number is well short of the 200 million CAD that Aphria needs to put them at about the halfway mark of the low end of its forecast.
Aphria Does Not Need Any More Poor Headlines
Aphria drew the ire of investors due to allegations of wrongdoing in how it acquired Latin American assets. As I wrote back in October, an independent committee (formed by Aphria’s board) found many of the allegations to be untrue. But the resulting conflicts of interest led to the resignation of former CEO Vic Neufeld.
If this was the company’s first offense it would be damaging. However, with it being a second offense, the company is skating on thin ice. Aphria is going to have a hard time meeting the revenue expectations that it has set.
What Should Investors Do with Aphria Stock?
Whenever I see a stock with the potential for a range of outcomes, I have to call it a hold. And that’s what I see with Aphria. The cannabis industry should have a better 2020 simply because most of the frothiness has been wrung out of the stocks. But as investors begin to look at these stocks based on their merits, what will they see?
In the case of Aphria, they have bought some time due to perfectly legal but unsustainable accounting measures. The company has yet to show the cash burn of its competitors. But it has already taken a 50 million CAD write-down on the previously mentioned Latin American transactions. And that is confirming the suspicion that Aphria overpaid for those assets. This means more write-downs, and share dilution, is likely.
All things considered, 2020 is the year many cannabis companies must begin to prove their case to investors. Until they do, investors can hit the pause button on Aphria.
As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.
