This is the first in an ongoing series of research examining Aphria’s (TSX: APH) business and share price. The purpose of undergoing this research is to help us determine the future direction of APH relative to Canopy Growth (TSX: WEED).
The highest risk/reward forecast we can make that we believe will impact the future stock price is anticipating Aphria’s next few quarter’s kilograms sold, profit per gram and EBITDA. Unexpected changes in kilograms sold can lead to changes in the trajectory of revenue and EBITDA and a re-valuation of the stock price by buy-side and sell-side.
We believe Aphria’s share price will increase (or decrease less) versus Canopy’s beginning from July 14th 2017 to the average last ten trading days closing price in October of 2019. The stock call is good for as long as Aphria’s share price has traded below $5.75 for the entire day and as long as it is listed on Perspectec.com. We are not allowed to trade Aphria or receive any form of compensation from any other parties besides subscribers.
The following are reasons why we like the stock over this time period:
Aphria can perform under any Provincial distribution strategy – With its low cost, high volume agnostic approach to end markets, Aphria has set itself up to handle whatever distribution model Canadian Provinces choose to take once recreational legalization happens. Expectations are that Provinces will not be ready with distribution and taxation plans by the Federal legalization date of July 1st, 2018. Still for the long run, the most popular strategies being considered are:
LCBO/CCBO concept in Ontario – In Canada’s largest province, Ontario Premier Kathleen Wynne has stated that she believes selling cannabis through the Liquor Control Board of Ontario (LCBO)’s distribution network “makes a lot of sense. A separate Provincial Cannabis Control Board of Ontario (CCBO) appears likely to us many months after July 2018. We assume this scenario playing out for our forecast. It is neutral to Aphria’s stock price.
Prior to the legalization of recreational cannabis, dozens of illegal storefront dispensaries not checking for prescriptions continue to get closed down in Ontario as municipal governments continue to enforce the law. We assume virtually no sales of Aphria from illegal storefront dispensaries and this news is neutral to Aphria’s share price.
Pharmacy Distribution – Pharmacies are positioning themselves to become the distributors for medical marijuana. In October of 2016, Shoppers Drug Mart (over 1,300 stores) applied to be a licensed producer of medical marijuana, opening them up to potentially selling it. Other pharmacies under any banner including Pharma Plus (about 450 stores) and London Drugs (about 80 stores) are also potential customers. Licensed producer CanniMed (TSX: CMED) signed the first letter of intent to be the exclusive supplier of a member-owned cooperative group PharmaChoice (representing over 700 locations) in March of this year. The deal will be completed and implemented 60 days after legislation makes storefront distribution legal on a Federal and Provincial level.
There are no indications that Provinces will stand in the way for Medical distribution. We believe with the commitment of achieving the lowest cash costs in the industry while simultaneously producing high quality products, Aphria would lead the list of licensed producers selling to pharmacies. We forecast a ramp-up of pharmacies selling Aphria’s marijuana for medical purposes at a rate of a few hundred kilograms a quarter starting sometime in the second half of 2018. Rates faster or slower than this will increase or decrease the stock price accordingly.
Competitor costs are materially higher – One of the more important figures to keep an eye on in the cannabis industry is the cash cost to produce one gram of weed. Aphria noted in its fiscal Q4 results that producers had been using a different definition when calculating the figure. They said the primary differences between Aphria’s definition and “certain competitors’” definition of cash cost to produce per gram is that Aphria includes the costs related to indirect labour expenses and quality control costs. If Aphria reported like said competitors then their cash cost per gram in the latest fiscal Q4 is $0.79 versus a competitor like MedReleaf (TSX: LEAF) at $1.53 per gram. Canopy Growth, while positioning itself as offering premium brands and products, is materially higher than both companies but their breakout of costs is less transparent.
Source: Company Reports and Perspectec
Source: Company Reports and Perspectec
Great market share potential – While there are dozens of licensed producers, nobody has a market share larger than 15%. We believe there will be enough growth in the market for at least a few producers to materially benefit on either/both of wholesale or distribution side. We see Aphria as a low cost leader targeting the wholesale market to a very large extent and being in the best position to benefit profitably over a long period of time.
Nearly fully funded for 10x growth – Aphria is fully financed and on track for its 30,000 kilograms of marijuana production per year (versus a run rate of 3,000 KG sold last quarter) expansion. The first sales from the expansion are expected to begin in May of 2018. We believe it may take until May 2020 for Aphria to reach a 30,000 KG run rate (7,500KGs a quarter). The price elasticity of cannabis, timing of Provincial legislation, taxation and success with signing large wholesale agreements will be key to Aphria’s success.
Debt versus Equity future financing – For its planned expansion to 100,000 Kilograms a year, we estimate another $60 million will likely need to be raised. While there is a big question mark as to whether they need that much space, this question does not need to be answered now. In our discussions with stakeholders, it appears the company is leaning towards debt financing. If product demand necessitates this larger facility, investors may not need to worry that their shares will be diluted materially from a major equity raise. The timing of an equity raise/debt raise is a major risk to our stock call.
Generally have met targets – Aphria has been delivering in what they said they set out to do. One example of this is that at the end of 2014, prior to reporting any cannabis sales, Aphria stated that their business plan was to ship 1,600 kilograms of pot on an annualized basis by the end of 2015, enough to supply 3,500 patients. Over a year later, Aphria’s fiscal Q3/16 saw them ship 1,300 kilograms of weed on an annualized basis for roughly 4,000 registered patients. From our experience, pre-revenue growth companies meeting their public expectations is not common. This has led to Aphria being able to get institutional money behind them for future equity raises and expansion.
Partnerships in key markets are a bonus – While Aphria has ownership and royalty agreements in place in Florida, Arizona and Australia that may be materially beneficial to future earnings, we view these as not essential at this time for the stock to move higher.
Strong profile compared to other LPs – Aphria’s management team has perhaps the strongest operational experience in the industry. Led by VP of Growing Operations Cole Cacciavillani and VP of Infrastructure and Technology John Cervini, their team has a combined 55 years of agri-business experience and over 20 years’ experience in pharma. Contrasting this, Canopy’s CEO splits time heading two companies and their senior team lacks the growing experience of Aphria’s.
Attractive valuation at a reasonable ramp-up – Our forecast values Aphria at 20x Q4/20 run rate EBITDA of $44 million. Some things to take notice of:
APH is trading at over 1,000x its trailing 12-month EV/EBITDA
We forecast EBITDA to grow by 60% to $31 million in 2020
Bloomberg sell-side consensus is $102 million, but we do not believe the majority of individuals doing the trading of APH believe Bloomberg figures for the company.
Established companies in regulated markets such as Philip Morris International in cigarettes and tobacco trades at 17x its 2017 EV/EBITDA.
Assuming net cash of zero and 136 million shares outstanding would give a share price of just below $7. We believe our assumptions are most realistic with no hidden biases.
In having modeled out Canopy to a similar extent, we believe their share price will depreciate even further. Current Bloomberg consensus has WEED reporting fiscal 2019 EBITDA (March 31, 2019 year-end) at $108 million versus our forecast of -$25 million. Again consensus estimates appear highly unlikely. We see Canopy growth having a difficult time reaching profitability over at least the next two years and this will take a toll on its share price. With a materially larger retail shareholder base than Aphria’s, our best guess at this time is that Aphria’s share price will appreciate (or depreciate less) versus Canopy Growth until October 2019.
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For the purposes of complying with NYSE, NASDAQ and all Self-Regulatory Organizations, Perspectec Inc. has assigned the following rating system BUY, HOLD/NEUTRAL, SELL for the securities which are the views expressed by an analyst, Independent contractor, and or an employee of Perspectec Inc. The information and opinions in these reports were prepared by Perspectec Inc. or an analyst, independent contractor. Though the information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Perspectec Inc. makes no representation as to its accuracy or completeness.
