In the days before and after Canada’s legalization of recreational cannabis in October 2018, marijuana stocks garnered a lot of attention. However, fewer legal stores than expected, regulatory delays, the illicit market, and other factors challenged legal sales, and the sector suffered huge losses in 2019. The Horizons Marijuana Life Sciences ETF, the industry benchmark, fell 36% over the course of the year.
However, the cannabis sector hasn’t entirely lost its steam. Marijuana was declared an essential item in Canada and many U.S. locales during the coronavirus pandemic, and most U.S. cannabis companies have seen spectacular revenue numbers this year. In general, though, Canadian companies are still facing issues — though one in particular is thriving. Aphria (NASDAQ: APHA) gives you some good reasons to buy.
Contrast this with Aurora Cannabis (NYSE: ACB), which has a spotty history that makes it hard to trust its efforts to recover this year. It has failed to meet its targets many times before. Both These two companies have similar market caps — Aurora at $1.1 billion, Aphria at $1.3 billion — but have a very different approach to business.
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Why Aphria is a good cannabis pick
Aphria cultivates and sells a variety of medical and adult-use cannabis products to consumers under brands like Aphria, Broken Coast, and Good Supply. After Canada legalized cannabis derivative products (vapes, edibles, beverages, and more) in October 2019, Aphria launched its vape products in the market.
Where peers are struggling to make profits, Aphria has seen positive EBITDA (earnings before income, tax, depreciation, and amortization) for five consecutive quarters, including its recent fourth quarter, ended May 31. EBITDA can be a good measure of how efficiently a company is handling its operating expenses, and Aphria’s consolidated adjusted EBITDA in the quarter was up a dazzling 49%, to 8.6 million Canadian dollars, from the year-ago quarter. Consistent hikes in revenue and gross profit were big drivers of this success.
Aphria’s strength in medical and recreational cannabis means high revenues not just in Canada but from international markets. And those revenues are increasing — even though they’re already among the highest in the industry. For fiscal 2020, Aphria’s revenue jumped 129%, to CA$543.3 million, from 2019. Meanwhile, Canopy Growth (NYSE: CGC), with a much larger market cap of $6.9 billion, reported a revenue increase of 76% year over year to CA$399 million for fiscal 2020. Canopy also launched a wide array of vapes, marijuana-infused beverages, and chocolates in May.
Aphria has been able to successfully achieve all this because of its strong leadership team under CEO Irwin Simon. Simon took charge as interim CEO in March 2019, before which he served as the independent chair of the board of directors. Since then, the company has shifted to an asset-light business model, focusing on its core operations and keeping its balance sheet tight. Simon’s track record is evident from the success of packaged goods company Hain Celestial, which he founded and ran for 25 years.
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Why you should think again before considering Aurora Cannabis
Demand for cannabis, and excitement about the sector, had Aurora’s management spending like crazy last year — acquiring other companies and expanding its production facilities without heeding the rising debt. But the external headwinds in the Canadian market, like illegal sales and a slower rollout of legal stores than had been expected, challenged revenues for pot companies, and Aurora was no different. Its mounting losses and debt burden pulled its stock price below $1, which is against New York Stock Exchange (NYSE) trading compliance. If a stock trades below $1 for long enough, it receives a delisting warning notification from the NYSE. CEO Terry Booth stepped down in February, which didn’t help; a sudden C-suite leadership change doesn’t usually sit well with investors.
Aurora had to take some drastic last-minute measures to save its stock from being delisted. It executed a one-for-12 reverse stock split on May 11. Better-than-expected third-quarter results also boosted the stock price, moving it over $1.
As with Aphria, revenue is rising for Aurora as well. But given that the companies have similar market caps, the difference in their numbers is vast. Aurora managed to reach CA$75.5 million in net revenue in its recent Q3 2020, ended March 31 — a year-over-year increase of 16%. The company is not even close to pulling off Aphria’s (or Canopy’s) revenue numbers for the full year.
Despite the hike in revenue, its EBITDA came in negative at CA$50.8 million, compared with a loss of CA$37 million in the year-ago quarter. This was because of a jump of 19% in selling, general, and administrative expenses (SG&A), to CA$75 million.
With all that said, management is making strides this year to reduce costs. They announced some operational changes — what the company calls a “facility rationalizations plan” — in June, closing five smaller facilities with plans to merge several others into one by the second quarter of 2021. Meanwhile, management intends to ramp up operations at their Nordic facility in Europe. These changes are intended to help reduce expenses, improve margins, and help Aurora hit profitability by the first quarter of 2021.
What’s worrisome, though, is that Aurora’s management has made similar promises in the past and failed to deliver. In its third-quarter 2019 earnings call, in May 2019, management spoke of their plan to report positive EBITDA by the fourth quarter of fiscal 2019. However, it failed to hit the target and instead reported a loss of CA$36.6 million. Losses kept accumulating thereafter, which makes it hard to trust management’s word on this.
Aphria is the better choice
Shares of Aphria and Canopy have fallen 10% and 20% so far this year, while Aurora has declined by 62.1%. Meanwhile, the industry benchmark, the Horizons Marijuana Life Sciences ETF, has dipped 25.3% over the same period.
Aphria is clearly the better cannabis pick over Aurora Cannabis — but the latter may not have reached a complete dead end. If its cost-cutting strategies work out, things could shine for the company again. We will know more in its fourth-quarter results, expected Sept. 9. For now, it’s a stock you should avoid.
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Marijuana Stocks: Buy This, Not That was originally published by The Motley Fool