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Canadian cannabis producers grow recreational sales as share prices wilt

Canada's largest cannabis suppliers continued to rake in more sales from the recreational market in second quarter 2019 as the industry readies for the legalization of new products, according to S&P Global Market Intelligence analysis.

Despite the revenue gains, share prices for several large Canadian cannabis companies dropped in the past year as those producers struggle to post profits. Stock performance for at least five of the largest Canadian producers fared worse than the S&P 500 in the 52 weeks through Sept. 30.

Revenue growing ahead of market expansion

Four Canadian cannabis producers reported a combined C$144.2 million in revenue for recreational-use cannabis in the second quarter of 2019, based on a review of the companies' most recent fiscal quarters.

Canopy Growth Corp., Aurora Cannabis Inc. and Tilray Inc. reported revenue for the three months ended June 30, while Aphria Inc.'s fiscal quarter ended May 31. The companies reported earnings for August and September.

The combined revenue figure does not include earnings for HEXO Corp., which has yet to report earnings for its most recent quarter, which ended in July. Cronos Group Inc. did not break out how much of its total revenue came from recreational-use cannabis sales.

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The same companies, excluding Hexo, reported C$105.4 million in combined revenue during the previous three months, reflecting sales during the first full quarter after Canada legalized recreational cannabis in October 2018. Analysts expect sales to grow in 2020 when a second wave of products including cannabis-infused edibles, extracts and topicals become legal in December.

Yet the path to profitability for Canadian cannabis producers remains a challenge. Four companies reported losses on an adjusted basis before interest, tax, depreciation and amortization for the most recent quarter, while Aphria alone reported positive adjusted EBITDA at just $209,000, according to Market Intelligence analysis.

Canopy Growth again reported the most recreational-use cannabis revenue with C$61.1 million for the second quarter of 2019, up from C$58.1 million in the previous quarter.

The company stands to gain once the newly legal products become available, according to an August report by Stifel analyst W. Andrew Carter. Canopy Growth sales could reach C$1.4 billion in fiscal 2021, Carter said.

Canopy reported C$253.4 million in revenue for fiscal 2019, which ended March 31, according to Market Intelligence data.

The company also plans to name a replacement for CEO Mark Zekulin, who became the sole CEO in July after co-CEO and co-founder Bruce Linton departed the company. New management is expected to bring more discipline to Canopy Growth's spending and capital allocation, enabling the company to grow without needing new capital, Michael Lavery, a PiperJaffray analyst, said in a Sept. 30 report.

"Cannabis investors appear to have shifted focus from revenues to earnings, cash flow, and capital position," Lavery said. "Canopy's strong balance sheet is an advantage vs. competitors."

Constellation Brands Inc., the maker of Corona and Modelo beers, owns 35.5% of Canopy Growth. The beer brewer in August forecast that the investment will result in a non-GAAP net loss of $38.5 million for Constellation's second fiscal quarter of 2020. Constellation will report earnings for the period on Oct. 3.

Trailing Canopy, Aurora Cannabis reported C$44.9 million in second-quarter recreational-use cannabis sales, a jump from the C$29.6 million reported in the previous quarter. Aurora predicted "volatile" revenue in future quarters during a Sept. 12 earnings call. This pushes back expectations for the company's profitability, Ryan Macdonell, a GMP Securities LP analyst, said in a Sept. 13 report.

Even as sales grow, the legal Canadian cannabis market still faces substantial, if waning, competition from the illicit market, according to the results of a quarterly government survey released in August.

Cannabis obtained through legal sources in the second quarter of 2019 totaled 49.2%, up from 21.7% a year ago before cannabis became legal in Canada, according to the survey. The illegal market provided 46.1% of cannabis, down from 51% from a year ago.

Sagging stocks

Stocks for some of the largest Canadian cannabis companies performed well-below 4.3% growth of the S&P 500 in the year ending Sept. 30, according to Market Intelligence data.

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Tilray, which has partnered with Anheuser-Busch InBev SA to research cannabis beverages, saw the steepest drop, with its share price falling 82.8% in the year ending Sept. 30. In September, Tilray announced that it had entered a definitive merger agreement with its largest stockholder, Privateer Holdings Inc. Tilray beat revenue expectations for the most recent quarter but missed on earnings per share and net income, according to Market Intelligence.

"Tilray's earnings underscored the preeminent themes in the industry: robust revenue growth opportunity bumping up against a higher degree of expense/investment necessary to capitalize on the 'once-in-a-lifetime' opportunity," Carter of Stifel said in an August note.

The second-biggest stock tumble came from Aphria. Its stock dropped 61.8% during a period when its CEO stepped down amid allegations that the company inflated a deal's value as part of a scheme to bilk shareholders. A special committee found the deal acceptable but recommended a review of Aphria's board composition and corporate governance training for directors and senior management.

Still, Aphria beat earnings expectations for the most recent quarter, an encouraging sign in the context of low credibility in the cannabis sector, Ryan Tomkins, a Jefferies analyst, said in an August report.

Additionally, Aphria delivered a "surprise" EBITDA that should be taken well as profitability becomes more of a focus in the cannabis sector, Tomkins said.