Altair
Well-known member
Anyone else reading this?
http://www.canadianbusiness.com/inv...ana-stocks-have-a-serious-accounting-problem/
http://www.canadianbusiness.com/blo...ic&utm_campaign=recirc&utm_content=img_single
http://www.canadianbusiness.com/inv...ana-stocks-have-a-serious-accounting-problem/
Depending on your point of view, the burgeoning marijuana industry in Canada is either an unprecedented opportunity to rake in huge profits as recreational use becomes legal, or a speculative bubble that will eventually pop. When forensic accountant Al Rosen looks at the sector, he sees something else: “It’s a bloody mess,” he says.
Rosen is referring to the financial statements of the country’s publicly traded licensed producers. Accountability Research Corp., which Rosen runs with his son, Mark, is warning those statements are misleading and allow companies to overstate profitability. “Canadian reporting of marijuana growers sets a new low for integrity,” the Rosens wrote in a recent report. It’s not that companies are intentionally duping investors—though there is ample opportunity for that, the Rosens argue. Instead, companies are trying to apply already-vague accounting rules to a new industry. Companies have to put a value on their marijuana plants for accounting purposes, even though pricing and future demand are not yet known. As a result, the Rosens charge, financial statements rely heavily on managers’ estimates, and are wildly inconsistent.
“If investors are using the numbers at all, there’s a serious chance they’re being misled, or they’re misinterpreting the numbers themselves,” Mark says. The issue is compounded by the fact that valuations are soaring, and companies are trading based on future projections that may never materialize. “It’s just adding to all of the speculation around marijuana, and feeding the frenzy,” says the elder Rosen.
To understand, gird yourself for a brief accounting lesson. The problem, according to the Rosens, starts with International Financial Reporting Standards (IFRS). Canada implemented IFRS accounting in 2011, following most other G20 countries (the United States remains an outlier). One of the goals of IFRS is to create a set of global standards to help facilitate international investing. The Rosens charge that IFRS is a step backward and gives companies too much leeway when it comes to reporting. A company, for example, can record revenue if management believes there is a 50.001 per cent probability of collecting the cash.
That brings us to gross margins—a measure of the difference between revenue and the cost of goods sold, such as labour and materials. It’s an important gauge of profitability. IFRS allows agricultural firms to use the estimated increase in the value of their biological assets, such as plants, to offset costs when calculating gross margins. It’s a little bit like counting chickens before they’ve hatched (perhaps literally). For mature agricultural industries, that can make sense. The market for tomatoes is well-established, prices are not in dispute, and a producer can enter into future sales contracts. That’s not the case with recreational marijuana sales, an industry that doesn’t even exist yet. Prices, costs, sales volumes and the quality of inventory are still very much up in the air.
Gross margins in the sector are distorted as a result, making firms look more profitable than they really are. Companies are boosting marijuana inventory in anticipation of legal recreational sales in July, and have much more weed than can possibly be sold at this point. That’s led to cases where some firms, such as Canopy Growth Corp., have reported gross margins in excess of 100 per cent. The situation makes it difficult for investors to truly gauge profitability—and it’s made worse by the fact that companies use different estimates to calculate the value of their plants, and they’re not always transparent about how they arrived at those values. “Even when you ask what number they’re using, they’ll give you a roundabout answer. It has been like pulling teeth sometimes,” says Jason Zandberg, an equity analyst who covers the sector at PI Financial in Vancouver. “They say, ‘Well, it changes every quarter.’ That’s just a bizarre way to carry out business.”
Some companies have taken to using their own metrics to more accurately represent margins. (In the parlance of accountants, these custom numbers are called non-GAAP adjustments.) Both Canopy and Aphria do so, but the figures aren’t comparable. Canopy excludes depreciation and amortization from its cost of sales, while Aphria includes the amortization of production equipment and greenhouse infrastructure. In the end, Canopy overstates gross margins relative to Aphria, according to the Rosens. Canopy has also changed the way it reported this figure last year, adding to the confusion. Since there is no consistent reporting across the sector, and even the non-GAAP adjustments are based on management estimates, investors are still poorly served, the Rosens argue. “It’s not definitely not a more useful tool,” Mark says.
http://www.canadianbusiness.com/blo...ic&utm_campaign=recirc&utm_content=img_single
As the July deadline for the provinces to legalize marijuana approaches, the stock prices of Canadian publicly-traded weed producers have been on a tear. On Monday alone shares in Canopy Growth Corp., soared nearly 20 per cent. The surge in market value comes as firms try to position themselves with sufficient product to meet anticipated demand. But as these companies, some valued in the billions of dollars despite generating no profits, continue to attract starry-eyed investors, it’s worth examining what kind of opportunities will exist for these firms when provinces regulate retail pot sales. It is not difficult to predict profit margins will fall under regulation and that current market cap valuations are predicated on unrealistic expectations.
While there are some variations across provinces in their distribution plans for legalized marijuana, the largest two provinces, Ontario and Quebec, intend to have provincial run outlets modelled on their government-controlled alcohol sales. Indeed, the alcohol model gives us an important clue as to how the industry is likely to shake out—and why marijuana producers face tough times ahead. Keep in mind that there will still be online purchases and the proportional divide between physical store and e-commerce is unclear. Ontario with only a planned 150 outlets might give us an early indication as to online traffic. But let us consider the possible ramifications from only the government outlets.
The Ontario Liquor Control Board (LCBO) and Société des alcools du Québec (SAQ) effectively have a monopoly on the sales of most alcohol products in their respective provinces (with the exception of beer and some wine). The LCBO is one of the world’s largest buyers and demands much from its suppliers in terms of large quantities and price discounts. Minor producers, even in Ontario, who are unable to meet the demands of the LCBO must sell their products elsewhere.
Giant provincial alcohol buyers with market power drive tough bargains in terms of price and quantity which dissipates suppliers’ profits. Of course, having a virtual monopoly on the retail side has meant that these pricing discounts are rarely passed onto its customers. I see the same tactics for recreational marijuana. There is the false belief that the licensed producers (LPs) of marijuana will get the same price from the provinces they have enjoyed in the retail-based medical market business. However, aggressive bulk buying by large provincial authorities will whittle the producer price down markedly.
Provincial buyers are going to want to deal with licensed producers that can supply large amount of product at low prices. At present the average price of medical marijuana is roughly $10 per gram. Some publicly traded companies have boasted that their all-in costs are in the range of 70 cents to $1.75 per gram which translates into profit margins of more than 80 per cent. However, we can expect provincial agencies will severely cut into these margins. The Ontario wine industry provides us with some idea of profit margins that LPs might reasonably expect. In a recent study on Ontario Wine and Grape Industry (2015), for large scale operations the profit margins are just under 15 per cent and in fact many smaller vineyards were posting losses.
Meanwhile at implementation this will likely mean only the largest producers will be entering into contract with the provincial authorities. The notion of boutique suppliers of cannabis will have to wait, just like craft beer producers waited in alcohol sales. Establishing reliable supply lines will dominate initially any gourmet pot considerations.
Will provinces favour producers in their own backyards? Of course they will. Just as Ontario has favoured its own wine industry and shelves mostly their products for the domestic lines in their stores, so will it be true for provincial distributors. For instance, if you are a cannabis producer hoping to sell in Canada’s biggest markets, you will likely need a physical grow-op in Ontario or Quebec. This means regional producers will face additional barriers to growth. At present only the government of New Brunswick has announced a commitment to Organigram, a Moncton-based producer, to buy five million grams a year. The company, which has seen its shares soar 31 per cent in value so far this year, estimates that deal will translate into a retail value of $40 million to $60 million. (At present, Organigram’s market value stands at $630 million.) Other provinces will soon follow suit I believe and strike distribution arrangements for local provincial growers.
As in many stock market interactions, the industry tells a rosy story of growth and opportunity. But I would suggest a careful recall of the dot com bubble offers a somber warning. Canopy Growth Corp. is currently valued at just over $7.5 billion yet loses about 12 cents a share. At the same time, Canadian Tire Corp. has a valuation of $11.5 billion and earns $10 a share—and pays a dividend yield of 2.14 per cent. What company offers a better long-term investment?
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