Medical cannabis companies will be the clear winners in the pot sector, Paradigm Capital says

Aphria’s (Aphria Stock Quote, Chart TSX, NYSE:APHA) latest earnings report is a sign that cannabis companies focusing more on the medical marijuana market may do better than companies with all their eggs in the rec weed basket, according to sector analyst Rahul Sarugaser of Paradigm Capital.

Amid the recent news concerning the stepping down of CEO Vic Neufeld and the still-lingering short-seller accusations regarding the company’s foreign assets, Aphria managed last week to also release its second quarter fiscal 2019 financials. The quarter which ended November 30 includes a good six weeks of data within the legalized recreational era in Canada and thus presents an early but still relevant snapshot of how the rec cannabis industry might be unfolding.

And for Sarugaser, the news isn’t good for those companies hoping to focus on rec versus medical sales. Aphria managed $21.7 million in quarterly revenue, a 33 per cent miss compared to analysts’ expected $28.8 million. For EBITDA, the company’s loss of $6.1 million was also a miss compared to the expected positive EBITDA of $1.2 million.

Importantly, the analyst points to the company’s average selling price, which came in at $6.54 per gram, down from the previous quarter’s $7.12 per gram and the $8.30 per gram in the quarter before that. As a result, APHA shows its gross margins dropping to 47 per cent versus 64 per cent and 79 per cent in the two previous quarters.

Sarugaser says the numbers paint a picture of dwindling margins in the rec sector, hobbled by marketing costs and the significant $1.00 per gram in excise taxes, effectively giving the advantage to companies favouring the medical over the rec market.

“While gross sales of adult-use cannabis are expected to outpace those of medical cannabis, we have yet to see the economics play out in favour of the adult-use cannabis market,” says Sarugaser in a research note on Friday. “Therefore, while SG&A and COGS for both adult-use and medical cannabis should find equilibrium over time, marketing costs associated with adult-use cannabis will continue to cannibalize its margins.”

“Furthermore, with the possible eventual alleviation of excise taxes from medical cannabis, we reiterate that we see more inherent value in medical-focused cannabis companies—such as CannTrust and Tilray than we do in adult-use-focused cannabis companies,” he says.

The analyst notes that Aprhia sold 1,900 kg during the first six weeks of the rec market for an average price of $6.54 per gram, while its average selling price for medical cannabis (where it sold 1,444 kg) over the quarter was $7.51, an 18 per cent premium.