Profits for most cannabis companies aren't expected in the near future, so when companies to announce positive EBITDA in their earnings report, it's important to look under the hood more to find out what the nature of those results entail, and if they are sustainable.
In this article we'll look at OrganiGram Holdings, Aphria, and Liberty Health Sciences, all of which have been posting positive EBITDA.
OrganiGram has received some accolades because of it being able to generate positive earnings for four quarters in a row. The good news is because of its smaller size in comparison to a number of market leaders, it should be able to continue to boost revenue and earnings for now, as it operates out of one 490,000 square foot facility, which is expected to increase the amount of kilograms it grows annually from 36,000 to 113,000 by the end of 2019.
OrganiGram is also one of three companies based in Canada that have sales agreements in all the 10 provinces in Canada.
One of the major strengths of Organigram is its unique growing system that allows it to grow almost twice as much cannabis per square foot than its closest competitors, and in most cases, it's over twice as much per square foot.
Another competitive advantage for now is its being the only large cannabis producer in Canada located in the province of New Brunswick. While it isn't a highly populated region, it does have the most cannabis usage based upon percentage of population. It also has little competition at this time.
I think Organigram should be able to remain the dominant player in the Eastern province for some time, but once the larger players saturate other areas of Canada, once more retail outlets are operational, there's not doubt to one degree or another, they'll start to focus on New Brunswick. That will take time, so Organigram should enjoy a competitive advantage in the near term.
Because of its one facility, increase in production capacity, and not having to spend on expansion, it should continue to improve earnings in the quarters ahead.
On the negative side, that which is a strength for Organigram under the current market conditions, will eventually become a weakness as the number of retail outlets in Canada scale across the nation. Its much larger competitors will be able to lower costs per gram as they scale in conjunction with the increase of retail stores.
The other concern is what Organigram will do for growth once it reaches production capacity. By that time its competitors should be starting to generate positive EBITDA as well, and it will struggle to show how it can match the long-term growth trajectory of many of its peers. Consequently, its share price will come under pressure.
On the other hand, Organigram also faces the same limitations its competitors do because of lack of places to sell cannabis in Canada. Because of its location and size, it is probably not going to be affected as much, but its revenue numbers have been subdued because of the ongoing shortage of retail outlets.
For now, there are questions concerning revenue growth that have no apparent answers because of its relatively small amount of production capacity when its fully operational.
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Not that long ago the market was very positive on the assumed potential of Aphria. Most of that came from the company posting a profit in a couple of quarters in a row. But once the dust settled and investors took a closer look, the outcome wasn't as impressive as it initially seemed, based upon headlines in the media.
When looking closer at the numbers it was found that the profits weren't coming from operations, but from other sources, including CC Pharma, a German distributor.
One major positive catalyst Aphria has going for it is it's doubling its production capacity, which should, over time, allow it to improve operational results from scale and increased revenue.
On the down side, Aphria lost its long-term supply deal with Aleafia, which it inherited with the acquisition of Emblem. This came from Aphria's inability to come close to meeting the 25,000 kilograms it was contracted for, selling only 2,226 kilograms over a period of four months ending on August 31.
On the face of it, it would appear this could be a positive because of low margins associated with wholesale pot, but in reality, it's profitable because it costs much less to convert, package and deliver.
In the short term Aphria is going to struggle to replace the revenue it was expected to generate from Aleafia.
After removing the gains outside of operations, net income plummeted from a $16 million gain to a loss of $30 million.
Even though Aphria reiterated it full year 2020 guidance of $650 t0 $700 million in revenue and $88 to $95 million in adjusted EBITDA, I think it's far too aggressive to reach.
Some of this will determined by, as with Organigram, how rapidly retail cannabis stores are rolled out, and the impact of cannabis derivatives on its performance.
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Liberty Health Sciences (LHSIF)
Recent numbers from Liberty Health Sciences show that while it had some help from non-operating events such as the sale of Chestnut Hill Tree Farm and a boost from fair value adjustments to its biological assets, it still would have at least broke even.
The sale of Chestnut Hill Tree Farm provided $14 million to the bottom line of the company.
In the latest quarter it posted a profit of $22.9 million with the inclusion of non-operational items. Operating profit came in at over $9.2 million.
A key reason for the solid performance was the ability of the company to have its operating expenses climb by a modest 3 percent year-over-year, while it was able to have sales jump by almost 380 percent.
One of the strengths of Liberty Health is it is able to produce solid results by focusing solely on the Florida market. This lowers costs because the firm doesn't need to increase spending in order to expand to other markets.
Canadian companies on the other hand have to spend more to expand in markets around the world in order to generate sustainable, long-term growth.
This is why in the near term companies competing in the U.S., in general, have superior results than Canadian companies, although that doesn't apply to the MSOs that are looking to take a permanent long-term lead in the U.S. market by issuing shares and taking on more debt for the purpose of acquiring assets.
OrganiGram, Aphria, and Liberty Health Sciences. have enjoyed some positive press and response to their ability to generate a profit before other cannabis companies have been able to.
In the case of Aphria, it has yet to prove it can consistently produce a profit when not including non-operational items. It will benefit from increased production capacity, but as with Organigram, has to wait until it can fully take advantage of the potential demand in the Canadian market with the increase in retail outlets. It also will have to prove it can boost revenue and wident margins from derivative sales over the next couple of quarters starting in 2020.
Of these three companies Liberty Health Sciences and Organigram should be able to continue to increase their revenue and earnings for some time. That said, as the companies stand today, eventually they'll face a ceiling on revenue and earnings that they'll have to deal with. For now, both are able to keep costs low because of their primary focus on a more limited geographic region. What happens when those markets are saturated will determine the long-term sustainability of their growth potential.
That time isn't likely to be here for a couple of years, but when the limitations of their business models are met, they will be forced to expand beyond their current capabilities, which will increase costs and put pressure on margins and earnings.
For now, I see OrganiGram Holdings and Liberty Health Sciences having more potential to sustainably generate profits, while Aphria will without a doubt outperform them on revenue. How the market responds to those results will determine the share price of the companies.
At this time the market is rewarding those that are able to reduce costs and generate a profit, but when market sentiment for cannabis improves, Aphria could be considered a much better long-term holding with more potential to reward shareholders.
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