Cannabis Watch: Aphria profit didn’t come from selling marijuana

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Aphria Inc.’s profits are about the paper, not the pot.

The Canadian cannabis producer reported its second consecutive quarter of profitability early Tuesday, posting net income of C$16.4 million on sales of C$126.1 million. But the company’s profits weren’t the result of a massive windfall in its cannabis business, instead coming from Aphria’s previously sliding stock price and a shift in its ownership stake in another company.

U.S.-traded shares of Aphria APHA, +24.54% APHA, +15.46% closed Tuesday’s regular session with a 24% gain, but had previously fallen just over 6% in the quarter it reported Tuesday. The fluctuations in Aphria’s share price leading up to Tuesday’s report boosted the company’s earnings by C$14.2 million because of the way the Canadian cannabis company values its convertible debt.

Valuing the convertible debenture relates directly to the company’s share price, which closed at $6.26 at the end of August, though it traded as low as $5.02 before it reported its fiscal fourth-quarter results.

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Another paper gain that helped push Aphria into the black for the quarter was an arcane change in accounting methods it uses to value its investment in Althea Group Holdings Ltd. AGH, -1.55%  . Aphria reduced its ownership stake and gave up its board seat and “ability to participate in Althea’s policy-making process” during the quarter, which allowed management to book profits of C$24.3 million, which it included as paper gains in its long-term investments.

Combined with the changes in value assigned to its convertible debentures, Aphria added roughly $30 million in paper gains to arrive at the profitable quarter.

Cannabis revenue itself rose to C$30.8 million from C$28.6 million in the fiscal fourth quarter. The company disclosed that an August fire at its Broken Coast operation in British Columbia — which Chief Executive Irwin Simon has previously called its highest-margin business — had a C$1.5 million impact that “would be made up in the balance of the year,” executives said in Tuesday’s earnings conference call. Aphria did not disclose the cause of the blaze in the call.

Executives also reiterated the company’s fiscal 2020 guidance of C$650 million to C$700 million in revenue, “slightly more than half” of which will come from the company’s CC Pharma drug distribution business. Chief Financial Officer Carl Merton said on the conference call that Aphria expects “annualized” Canadian marijuana revenue of $1 billion by the end of calendar year 2020 (Aphria’s fiscal year-end occurs in May).

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Seaport Global Securities analyst Brett Hundley called Tuesday’s results “solid” amid a “marketplace that badly needed positive data points.” Hundley is referring to a broad decline in the sector over the past several trading days, spurred by a revenue warning issued by Hexo Corp. HEXO, +8.47% HEXO, +0.60%  last week.

“In our view, the company is optimistic regarding FY2020 guidance, and we leave our forward estimates well short of its forecast, as a result,” Hundley, who has an C$8 target price and a buy rating on the name, wrote in a Tuesday note. “That said, we think this is a company that is armed and ready to prove us wrong, while also being appropriately positioned should we ourselves prove to be right.”

GMP Securities analyst Justin Keywood also wrote in a note to clients that Aphria’s results were “solid,” and that they lined up with the “scuttlebutt” that his team had been hearing about improvements to operations and customer loyalty, among other things.

Jefferies analysts Owen Bennett called the results “strong” and said in a note to clients that most promising from the earnings were Aphria’s gains in market share — executives in the conference call said it had captured a 12% share in Ontario — coupled with continued profitability and reiteration of its sales guidance. Bennett has a buy on the name with a C$11 price target.

Aphria shares have fallen 65% in the past year, as the S&P 500 index SPX, +1.00%  has gained 7.8%. The ETFMG Alternative Harvest ETF MJ, +6.57%  , which tracks a basket of cannabis stocks, among other names, has fallen 53% in the past year. Horizons Marijuana Life Sciences Index ETF HMMJ, +5.12%  has dropped 55% in the past year.

Check out: Cannabis Watch — All of MarketWatch’s coverage of cannabis companies