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The Major Challenge These 3 Profitable Cannabis Stocks Face

Aphria (APHA), Trulieve (TCNNF) and Organigram (OGI) have separated themselves from most of the cannabis pack, based upon managing to turn a profit.

In the near term I believe these three companies should continue to do well, but in the longer term, they face challenges concerning profitability that some of their larger competitors decided to deal with in the early stages of growth.

For that reason these companies are getting rewarded now, but that could change as the tide turns and they are forced to look for ways to grow both the top and bottom lines.

In this article we'll look at what that challenge is and the potential impact on the long-term growth and potential profitability of the three companies.

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What the market is looking for now

With the fear trade on in the broader market and investors starting to look for profits in the cannabis industry, those companies able to generate a profit at this time are being rewarded for their performance.

I've mentioned for awhile now that the market was transitioning from a primary focus on growth and revenue to profits in the cannabis sector. That moment has obviously arrived from the way investors have been responding to those generating a profit, with the caveat of whether or not they'll be able to maintain that profit if they enter into serious expansion.

But for the next three quarters or so, I see the market continuing to look for profits in the cannabis sector until questions start to arise concerning how the companies will grow their top lines.

In other words, I see the market reversing direction, probably by the end of the first calendar 2020 quarter, and by latest, the second calendar quarter.

The reason for that is because by that time, as far as Aphria and Organigram go, Canada will have at least a full quarter of two of derivative sales, which will give a clear picture as the potential upside for both the top and bottom lines.

With sales likely to jump in Canada from derivative products and the increase in retail outlets, investors are going to want to see how the companies is going to grow revenue going forward.

Trulieve (TCNNF)

The challenge these companies face is they are positioning themselves as being able to generate a profit, when in reality the major reason for that is because of their more modest expansion goals in the near term.

For example, Trulieve is the dominant player in Florida, but is now staring to look outside that market for growth. It will eventually be forced to spend a lot of money to gain market share in other markets, and they aren't likely to duplicate its performance in Florida because competitors already are taking a significant piece of the markets Trulieve will be competing in.

Eventually this will put downward pressure on earnings, and the market will punish it under that scenario, unless it reports significant revenue growth at the time it starts to boost expenditures.

OrganiGram (OGI

As for OrganiGram, the location of its base on the Atlantic coast has given it an edge on competitors for now, but after they are finished battling for market share in Quebec and Ontario, they will expand to the less populated parts of Canada. The company will face a lot more competition when that happens.

Because of its unique growing process, OrganiGram is one of the market leaders in yield. According to the company, it produces about 230 grams per square foot, against the industry average of between 75 and 125 grams per square foot.

With the goal of producing 113,000 kilograms annually, the upside potential of OrganiGram is limited, and I think it'll struggle to maintain market share once its larger competitors take aim at the primary market it competes in.

Its yields are a competitive advantage now, but when its larger competitors, through much larger scale, cut back their price per gram as well, much of its current competitive advantage is going to evaporate.

Aphria (APHA)

Of these three companies, Aphria appears to have the best chance at sustainbly enjoying revenue and earnings growth over the long haul. Its production capacity will eventually climb to about 255,000 kilograms a year, which will only be behind a couple of its larger competitors.

It also has a strong balance sheet of $464 million of cash and marketable securities, giving it a cushion in the current soft cannabis market.

Looking ahead, it guides for revenue of C$650 million to C$700 million and adjusted Ebitda of C$88 million to C$95 million for fiscal 2020.

As with the majority of its Canadian-based counterparts, it did miss on revenue in the latest quarter, although that is without a doubt the consequence of the slow rollout of retail outlets in Canada. That should vastly improve over the next several quarters.

Conclusion

In the near term I think Aphria, Trulieve and Organigram should continue to do very well, as long as they continue to generate profits.

Once investors start to look for future prospects for revenue growth, at that time I think these companies could start to receive downward pressure if they haven't shown the market how they're going to grow over the long term.

Of these three, I think Organigram is the most susceptible to weakness, followed by Trulieve, because of its primary exposure to Florida, and the need to spend a lot more to keep up with fast-growing MSOs, who as with their larger Canadian peers, are taking their hits now rather than later.

Aphria in my view has the best chance of these three to generate probable long-term sustainable growth on the top and bottom lines. I'm not convinced it'll be able to keep up with its larger competitors as they grow while slashing costs, but it has the potential to at least keep near the top in the Canadian market. How it competes internationally in the years ahead will probably dictate its ultimate success.

For now though, all three of these companies should enjoy strength in their share prices as long as the market favors profitability over growth. Once that changes, they will face challenging times because of how larger competitors are boosting sales while turning a profit.

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