The Canadian cannabis industry has been plagued with plenty of issues since its inception. Many pot companies have experienced massive declines in their market value over the past year. The slow rollout of retail stores in major Canadian provinces led to lower-than-expected demand, which drove inventory levels higher, resulting in massive writedowns and lower profit margins.
Health concerns related to vaping, the illegal market's cannibalization of market share, and mounting operating losses have wiped out significant gains across the industry in the past year. However, there are two marijuana companies north of the border defying the trends of margin pressure and slowing revenue growth. Aphria (APHA) and OrganiGram (OGI) are profitable Canadian cannabis companies that are also listed on U.S. exchanges.
Let's look at why these two pot players can be winning bets for long-term investors.
Aphria's stock is 80% below record highs
Shares of Aphria are trading at $2.91 as of April 3. The stock is down 80% from its record high in January 2018, so it's lost considerable value. However, while most cannabis companies are grappling with widening losses, Aphria reported a profit in two of the past three quarters.
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In both instances, the bottom line was given a boost by fair-value adjustments. In the pot industry, plants cultivated for sale are biological assets. The fair-value adjustment is the difference between the revenue these plants are expected to generate and the cost incurred to harvest them, including the selling costs. Even given these adjustments, a positive net income figure is a rarity in the nascent marijuana industry.
In the past six months, Aphria reported a net income of 8.5 million Canadian dollars. The company's revenue rose by a staggering 550% year over year to CA$120.6 million in the fiscal second quarter of 2020, which ended in November.
In the second quarter of 2020, Aprhia reported an adjusted EBITDA of CA$1.9 million, compared with an EBITDA loss of CA$9.5 million in the prior-year period.
Aphria is well poised to generate sales from the growing European medical marijuana market. Its subsidiary, German distribution company CC Pharma, is a huge player in the medical marijuana space. And Aphira's distribution operations business is carried out by its wholly owned subsidiaries, including ABP, CC Pharma, and FL Group. This segment reported sales of CA$86.4 million and accounted for 72% of total revenue in Q2.
Another reason why Aphria might be a winning bet is the company's strong balance sheet. While several pot stocks need to raise additional cash to keep operations going, Aphria's cash balance is close to CA$500 million. Management is confident that it has enough liquidity to invest in capacity expansion and operational activities over the next 12 months. In the last six months, Aprhia's liquid sources of cash fell by CA$73.3 million. Considering a similar burn rate, the company has enough reserves for the next three years.
However, it is likely that Aphria will continue to grow inorganically as well as invest in capital expenditure in the upcoming quarters that will drive the cash balance lower. Currently, its financial position is enviable compared to other loss-making peers.
Further, if the cannabis markets continue to underperform, Aphria could potentially acquire several companies at discounted prices, which could drive revenue higher in the coming years. In order to expand its international footprint, Aphria aims to establish operational hubs in regions where there are significant growth opportunities. It is heavily investing in such assets via acquisitions and will likely continue to do so. The company's access to key international markets has already contributed directly to top-line growth.
OrganiGram's stock is 74% below record highs
Shares of OrganiGram are trading at $1.62. The stock has fallen 79% from its record high in May 2019. While Aphria's net income was driven by fair-value adjustments, OrganiGram generated an operating profit in the first quarter of fiscal 2020.
The company has benefited hugely from its presence in one of Canada's eastern Atlantic provinces. While most pot companies are eyeing larger Canadian cities in the population-heavy provinces of British Columbia and Ontario, OrganiGram secured a leadership position in the country's eastern provinces, including Prince Edward Island, New Brunswick (where it's headquartered), Nova Scotia, and Newfoundland. According to a Global News report published last year, these four provinces have a higher per-capita consumption of weed compared to the national average. OrganiGram also has supply agreements in all Canadian provinces, giving it access to a significant portion of the country's population.
Another key reason for the company's race to profitability: the multi-tier production facilities that allow OrganiGram to grow significantly more pot per square foot compared with the industry average. It has just a single cultivation facility, allowing the company to cut costs and improve efficiencies in terms of production output.
Despite higher marketing and staffing expenses, OrganiGram reported an adjusted EBITDA of CA$4.86 million in Q1, which was lower than its EBITDA of CA$6.83 million in the prior-year period.
Pot stocks will be volatile in the short term
Ontario is likely to increase the number of retail stores, which will normalize the demand-supply gap to a certain extent. While other provinces are expected to follow suit, the current COVID-19 pandemic will continue to affect demand in the short term; cannabis is highly regulated in Canada, and while delivery is available in some areas, many consumers still need to visit retail stores to purchase pot products.
For example, while British Columbia does allow online orders of cannabis products, customers will still have to go collect them at the post office. This will be a key deterrent to sales in times of self-quarantine and social distancing.
However, the long-term prospects for marijuana companies remain robust. Currently, 12 states in the U.S. have completely legalized marijuana, including states such as Washington and Vermont that are close to Canada, making them an attractive market for pot producers. As more states join in legalization -- New Jersey and New Hampshire are two that look likely -- it will expand the total addressable market for Aphria, OrganiGram, and peers, driving revenue growth in the upcoming decade.
The pullback in the stock prices of Aphria and OrganiGram makes both companies an attractive buy for growth, value, and contrarian investors. Further, the two pot companies are among the few marijuana players to post a positive EBITDA margin.
The current cannabis space is similar to what the dot-com market was at the start of this millennium. While there were several internet and e-commerce players then, only a handful of them were left standing at the end of the subsequent recession -- the ones with strong fundamentals, little debt, and enough cash to sustain a downturn.
The cannabis segment currently has multiple players, but only a few of them may survive if the COVID-19 pandemic results in a full-blown recession. Marijuana companies will find it difficult to raise equity capital, and banks may be wary of investing in unprofitable companies. It is very likely that cannabis stocks such as Aphria and OrganiGram that have significant cash and positive margins may come out as winners in the long term.
