The approval of the cultivation license at Aphria Diamond is a major milestone for Aphria (APHA). The Canadian cannabis producer can now fully implement their target of 255,000 kg of annual production capacity. The stock initially rallied on the news, but investors quickly took profits on the jump as the market is now fully focused on profitable capacity growth and not just building a big greenhouse facility.

More Than Doubling Capacity

The Diamond One facility is 51% owned by Aphria and includes 1,300,000 square feet of production space with an annual growing capacity of 140,000 kg. The company last reported production capacity of 115,000 kg bringing the total annualized production capacity to 255,000 kg.

The reality is that Aphria just increased potential production capacity by more than 120%. The key here is that the cannabis company only sold south of 6,000 kg in the quarter ended August 31.

Aphria still needed to sell over 28,000 kg per quarter in order to max out the previous capacity. The 4-fold sales target would normally be considered aggressive in most markets.

The new quarterly sells goal has to increase 10-fold to over 60,000 kg. The company can discuss all the benefits of industry-scale automation technology in a brand-new greenhouse facility, but the market wants to see these facilities generate positive cash flows from products that are starting to behave like normal commodities.

Moving Beyond Capacity Growth

Both Aurora Cannabis (ACB) and Canopy Growth (CGC) already have quarterly production approaching the target of Aphria so the company clearly has no market lead in pure production capacity. The place where Aphria leads is via more reasonable expansion tying into more limited operating expenses allowing the company to be EBITDA positive at this crucial junction for the Canadian cannabis sector.

These production goals will help the company reach revenue targets of up to C$700 million for FY20. The revenue shift into recreational cannabis with margins over 50% from distribution revenues with low margins is needed in order to achieve the big EBITDA target of up to $95 million for this fiscal year.

The adult-cannabis revenue needs to more than double from the C$30 million level during FQ1 to reach these goals. These numbers are very crucial considering EBITDA has to average C$30 million per quarter for the rest of FY20 after only producing C$1 million in FQ1.

Considering the massive cannabis supply flood hitting the market and the likely lower margins during the Cannabis 2.0 ramp up, the market is having a hard time deriving how Aphria reaches lofty goals of profit improvements in the near term.

C$11.00 price target

In a very upbeat report, Jefferies analyst Owen Bennett explained yesterday why he is reiterating a Buy rating on APHA stock. The analyst noted, "Aphria trades at a discount to larger-cap peers, even when adjusting for non-cannabis sales, and this is reflected in consensus, which suggests little conviction in Aphria hitting their targets. Consensus FY20 sales are currently at C$583m, with recent estimates even coming in as low as C$508m. We believe this sets Aphria up extremely well to be able to continue to surprise to the upside in FY20."

Bennett has also suggested that if everything goes as planned, APHA will be a C$11.00 stock in the next 12 months, implying about 70% upside from current levels. (To watch Bennett's track record, click here)

Takeaway

The key investor takeaway is that Aphria remains the best bargain in the large Canadian cannabis sector. At $4.82, the stock only has a market value of $1.21 billion while the market debates whether the capacity more than doubling is good or bad.

If Aphria does reach their FY20 EBITDA targets, the stock is set to rally. Considering the forecast was reinforced just a few weeks back in mid-October, investors should have stronger confidence in the targets. More confidence would exist if the bigger players in the sector would commit to not push production to full capacity of their new facilities.

The stock has a reasonable value at these levels, but Aphria may have a hard time achieving EBITDA growth targets so investors need to be prepared for a volatile few quarters ahead.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.