The cannabis industry has been on fire since the new year began, and it’s not hard to understand why. The passage of the Cannabis Act in Canada last year allowed recreational weed to be legalized for the first time in an industrialized country, paving the way for marijuana and marijuana stocks to step out of the shadows and into the mainstream.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="But the ascent of the cannabis industry hasn't been perfect, even if the share prices of pot stocks would suggest otherwise. Supply-chain issues in our neighbor to the north have dramatically slowed sales in recent months, with cannabis-store sales in January actually falling almost 5% from the sequential month of December. Regulatory red tape, compliant packaging shortages, and the need for growers to continue upping capacity and building out greenhouses has really sapped the industry’s very-near-term growth potential.” data-reactid=”12″>But the ascent of the cannabis industry hasn’t been perfect, even if the share prices of pot stocks would suggest otherwise. Supply-chain issues in our neighbor to the north have dramatically slowed sales in recent months, with cannabis-store sales in January actually falling almost 5% from the sequential month of December. Regulatory red tape, compliant packaging shortages, and the need for growers to continue upping capacity and building out greenhouses has really sapped the industry’s very-near-term growth potential.
However, these supply issues are far from the only concern for investors, as they learned the hard way this past week.
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<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Aphria delivers a mammoth writedown on its most controversial asset” data-reactid=”26″>Aphria delivers a mammoth writedown on its most controversial asset
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="On Monday, before the opening bell, Ontario-based Aphria (NYSE: APHA), which currently slots in as the third-largest producer by peak annual output at 255,000 kilos, reported its fiscal third-quarter operating results. Net revenue for the three months ending Feb. 28, 2019 catapulted 240% from the sequential quarter and 617% from the prior-year quarter, to 73.6 million Canadian dollars. That might sound fantastic, but with sequential kilograms sold actually falling from the second quarter, the bulk of the sales increase was the result of adding revenue from its recently acquired Latin American assets and CC Pharma, a distributor of pharmaceutical products in more than 13,000 pharmacies throughout Germany and Europe.” data-reactid=”27″>On Monday, before the opening bell, Ontario-based Aphria (NYSE: APHA), which currently slots in as the third-largest producer by peak annual output at 255,000 kilos, reported its fiscal third-quarter operating results. Net revenue for the three months ending Feb. 28, 2019 catapulted 240% from the sequential quarter and 617% from the prior-year quarter, to 73.6 million Canadian dollars. That might sound fantastic, but with sequential kilograms sold actually falling from the second quarter, the bulk of the sales increase was the result of adding revenue from its recently acquired Latin American assets and CC Pharma, a distributor of pharmaceutical products in more than 13,000 pharmacies throughout Germany and Europe.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="But Aphria's sales growth wasn't the talking point of its third-quarter report. Nor was it Aphria's proclamation that shareholders reject Green Growth Brands‘ hostile takeover offer for the company. Rather, it was the company announcing a CA$50 million non-cash impairment charge to the carrying value of its Latin American assets, which were acquired for CA$195 million. This impairment charge, which we’ll just simplify by calling a writedown, was the result of the Ontario Securities Commission requesting the company perform an impairment test on its Latin American assets.” data-reactid=”28″>But Aphria’s sales growth wasn’t the talking point of its third-quarter report. Nor was it Aphria’s proclamation that shareholders reject Green Growth Brands‘ hostile takeover offer for the company. Rather, it was the company announcing a CA$50 million non-cash impairment charge to the carrying value of its Latin American assets, which were acquired for CA$195 million. This impairment charge, which we’ll just simplify by calling a writedown, was the result of the Ontario Securities Commission requesting the company perform an impairment test on its Latin American assets.
The end result in the third quarter, mostly as a result of this writedown, was a net loss of CA$108.2 million, or CA$0.43 per share — the biggest eyesore on Aphria’s income statement in the company’s reasonably short history as a marijuana company.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="What makes this writedown so particularly tough to swallow for Wall Street and investors is that, in early December, short-seller Quintessential Capital Management and forensic analysis firm Hindenburg Research alleged that Aphria grossly overpaid for its Latin American assets. Although an independent committee found the acquisition costs to be within an acceptable range, new financial information revealed lower gross margins and EBITDA margin, along with higher-than-expected expenses, necessitating the adjustment. In other words, in a roundabout way, Quintessential and Hindenburg’s analysis was proven partially correct.” data-reactid=”30″>What makes this writedown so particularly tough to swallow for Wall Street and investors is that, in early December, short-seller Quintessential Capital Management and forensic analysis firm Hindenburg Research alleged that Aphria grossly overpaid for its Latin American assets. Although an independent committee found the acquisition costs to be within an acceptable range, new financial information revealed lower gross margins and EBITDA margin, along with higher-than-expected expenses, necessitating the adjustment. In other words, in a roundabout way, Quintessential and Hindenburg’s analysis was proven partially correct.
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<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="This is also problematic for Aphria, given that an independent committee discovered that insiders had potential conflicts of interest in its Latin American acquisitions. This is what led longtime CEO Vic Neufeld to step down.” data-reactid=”47″>This is also problematic for Aphria, given that an independent committee discovered that insiders had potential conflicts of interest in its Latin American acquisitions. This is what led longtime CEO Vic Neufeld to step down.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="In short, Aphria's management was already suffering from a crisis of confidence, and this writedown didn't help the situation, with the company's stock losing 15% on Monday.” data-reactid=”48″>In short, Aphria’s management was already suffering from a crisis of confidence, and this writedown didn’t help the situation, with the company’s stock losing 15% on Monday.
<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Don’t say you weren’t warned ” data-reactid=”49″>Don’t say you weren’t warned
Yet, what might be most worrisome is that Aphria is unlikely to be the last pot stock to take a writedown on the value of its acquisitions. Aphria ended the quarter with CA$674.4 million in goodwill out of CA$2.05 billion in total assets, and its balance sheet is rich with premium and hope, rather than tangible assets. There are quite a few marijuana stocks that are in a similar situation and could soon be looking at writedowns of their own.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="For example, Aurora Cannabis (NYSE: ACB) might be the most popular pot stock of them all, at least among millennials, but it’s lugging around a dangerous amount of goodwill and intangible assets. Aurora, the largest projected marijuana producer in the world with up to an estimated 780,000 kilos of peak yearly output, has used acquisitions as a core means of long-term growth. This has included the roughly CA$2.6 billion purchase of MedReleaf and the more than CA$1 billion acquisition of CanniMed Therapeutics.” data-reactid=”51″>For example, Aurora Cannabis (NYSE: ACB) might be the most popular pot stock of them all, at least among millennials, but it’s lugging around a dangerous amount of goodwill and intangible assets. Aurora, the largest projected marijuana producer in the world with up to an estimated 780,000 kilos of peak yearly output, has used acquisitions as a core means of long-term growth. This has included the roughly CA$2.6 billion purchase of MedReleaf and the more than CA$1 billion acquisition of CanniMed Therapeutics.
Looking at the CA$4.88 billion in total assets on Aurora’s balance sheet at the end of the most recent quarter, CA$3.06 billion was in goodwill, with another CA$689 million in intangible assets. Put in another context, Aurora Cannabis is being built on hope rather than tangible assets, and that’s often the recipe for a future writedown.
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<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Another potential culprit is the largest publicly traded marijuana stock in the world, Canopy Growth (NYSE: CGC). Canopy’s third-quarter operating results, released in mid-February, show a company with CA$8.64 billion in total assets and CA$1.82 billion in goodwill. A large portion (just above CA$4.9 billion) of total assets is comprised of cash and cash equivalents, thanks to a major investment from Constellation Brands. However, with acquisitions being a sizable component of Canopy’s long-term growth strategy, it could be difficult for the company to recoup the value of the premium tied to these transactions that it’s recorded as goodwill. ” data-reactid=”65″>Another potential culprit is the largest publicly traded marijuana stock in the world, Canopy Growth (NYSE: CGC). Canopy’s third-quarter operating results, released in mid-February, show a company with CA$8.64 billion in total assets and CA$1.82 billion in goodwill. A large portion (just above CA$4.9 billion) of total assets is comprised of cash and cash equivalents, thanks to a major investment from Constellation Brands. However, with acquisitions being a sizable component of Canopy’s long-term growth strategy, it could be difficult for the company to recoup the value of the premium tied to these transactions that it’s recorded as goodwill.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="The fact is that marijuana stock investors have been so enamored by growth and acquisitions that they've been mostly ignoring the rapid uptick in industry goodwill. Frankly, it’s unclear if pot stocks have made smart decisions when it comes to acquisitions, and there are zero guarantees that Aphria, Aurora Cannabis, or Canopy Growth will recoup the premium paid for their respective buyouts. More writedowns are likely coming, so don’t say you weren’t warned.” data-reactid=”66″>The fact is that marijuana stock investors have been so enamored by growth and acquisitions that they’ve been mostly ignoring the rapid uptick in industry goodwill. Frankly, it’s unclear if pot stocks have made smart decisions when it comes to acquisitions, and there are zero guarantees that Aphria, Aurora Cannabis, or Canopy Growth will recoup the premium paid for their respective buyouts. More writedowns are likely coming, so don’t say you weren’t warned.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content=" More From The Motley Fool ” data-reactid=”67″> More From The Motley Fool
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.” data-reactid=”72″>Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.
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