The Canadian cannabis sector continues to see sales expand while the related stocks haven’t generally rallied. Aphria (APHA) is a prime example of a sector stock unable to generate any momentum due to a reset of expectations to more reasonable levels. My investment thesis remains bullish on the stock here around $6 after urging investors to buy below $4 during the COVID-19 crisis.

APHA Aphria Inc. daily Stock Chart

Breakout EBITDA

The main Canadian LPs have suffered from an inability to reach positive EBITDA due to over production and expense structures built for global companies multiple the size of current business. Aphria is one of the only companies to already generate EBITDA profits and the soon-to-be released quarter is the potential breakout quarter for the stock and the sector.

Aphria had previously promoted some very aggressive EBITDA numbers while the other large Canadian cannabis LPs like Aurora Cannabis (OTC:ACB) and Canopy Growth (OTC:CGC) can’t even figure out how to eliminate large losses. A year ago when reporting the FQ1 results, Aphria outlined a path to adjusted EBITDA between C$88 million and C$95 million for FY20:

Source: Aphria FQ1’20 earnings release

The company had only reported a quarter where adjusted EBITDA was just C$1 million. Aphria spinning this level of EBITDA into another C$90 million over the next 3 quarters appeared highly unlikely. The update even came halfway into FQ2’20 leaving only 7.5 months left in FY20. Unsurprisingly, Aphria came nowhere close to reaching those targets in part due to COVID-19.

For this reason, the upcoming FQ1’21 earnings on October 15 are so crucial. Aphria actually hit FQ4’20 adjusted EBITDA of C$8.6 million and the current estimates are for numbers to nearly double in the last quarter.

Industry data have shown Aphria taking market share in a growing market. Canadian cannabis sales grew substantially in July with sales up 15% to C$232 million. In fact, July monthly cannabis sales were up 50% from the levels below C$150 million when the year started.

Source: Statista

Cantor Fitzgerald has Aphria growing vapes and flowers at a strong sequential rate. Unfortunately, the vast majority of revenues come from the CC Pharma medical cannabis distribution business in Germany. The business is roughly C$100 million of quarterly revenues or over 60% of revenues in FQ1’21 with recreational cannabis revenue jumping from C$53.1 million last quarter to over C$60.0 million in FQ1.

All of this leads up to a substantial boost in adjusted EBITDA numbers. Last quarter reported $6.5 million and the forecast is for quarterly EBITDA to nearly double here to $12.1 million. Cantor Fitzgerald has forecast Aphria beating estimates with a $12.9 million target for the quarter for nearly 100% sequential growth.

ChartData by YCharts

A big EBITDA beat is important as the Canadian LPs have long failed to meet targets and show any meaningful profits. This quarter is set up for Aphria to approach meaningful EBITDA margins in the 10% range. The sector is finally far more investable, with goals of generating positive cash flows.

Surprising Value

If Aphria can reach original FY20 EBITDA targets in FY21, the stock would only trade at ~20x estimates. The stock has a $1.6 billion market cap and an EBITDA target of $80 million appears possible. Like some of the multi-state operators in the U.S., the stock actually becomes investable based on actual bottom-line results.

Aphria no longer trades based on pie-in-the-sky cannabis projections. The company is set to benefit from loosened COVID-19 restrictions in Canada and additional cannabis stores in Ontario and Quebec.

Another failure to hit targets would crush the stock back to the low $4s. Like the Canadian cannabis sector in general, Aphria has constantly failed to reach financial targets. In the last 12 quarters, the company has only beaten both revenue and EPS estimates in 3 quarters. A 25% hit rate isn’t going to cut it going forward for the stock to rally above $6.

My previous research had warned of the company missing aggressive EBITDA targets while the stock was still appealing. Now, Aphria finally beating estimates and providing reasonable guidance for the rest of FY21 would be a game changer for the stock.

Takeaway

The key investor takeaway is that Aphria isn’t an ideal Buy here near $6 when the stock was easily closer to $4 for a large part of the last year. Regardless, the Canadian cannabis stock is likely headed higher on a breakout EBITDA number. The stock is cheap here and a prime reason that Cantor Fitzgerald slapped a $11.75 price target on Aphria.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

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