Marijuana Stocks: Let the Writedowns Begin

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.

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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Aphria delivers a mammoth writedown on its most controversial asset

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.

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.

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.