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MedReleaf Corp.’s Q2 Results Weighed Down by Policy Changes and Rising Costs

MedReleaf Corp. (TSX:LEAF) released its second-quarter results for fiscal 2018 on Monday. In the quarter, the company saw a 9% decline in sales from last year, and MedReleaf incurred a loss of $2.1 million — down from the $3.7 million profit that it posted in 2016.

Given the high growth that we’ve seen from many other cannabis stocks, MedReleaf’s results are a little bit concerning. Let’s take a deeper look into the results to see why the company had such a disappointing quarter.

Policy changes impact growth

In November 2016, the Veterans Affairs Policy (VAC) implemented a rule for cannabis where veterans would only be reimbursed for up to three grams of dried cannabis per day. However, there would be a six-month transition period, which ended in May of this year. The VAC also has set the maximum rate for reimbursement at $8.50 per gram.

These changes have had an impact on MedReleaf, and the company blames the policy changes behind its sales decline. In response to the VAC changes, MedReleaf has cut its average selling price from $12.61 a year ago to just $9.34 per gram, but that is up from $9.04 in Q1.

MedReleaf sold 1,051 kilograms of cannabis in Q2, which is up 23% from a year ago. However, a 26% drop in price has more than offset the increase in volume, which also could have been greater if not for the VAC changes that put daily caps into place.

Veterans are able to apply for exemptions to the limits, and the company saw a rise in the number of approved requests in Q2.

Cost per gram reaches all-time low

MedReleaf was able to achieved an average cost per gram sold of $1.46 this quarter, which was down from $1.49 in Q1 and is the lowest cost that the company has achieved.

Rising operating expenses erode gross profits

Despite the restrictions placed by the VAC, MedReleaf’s gross profit rose 22% year over year. However, operating expenses of $11.69 million almost completely wiped out gross profits of $11.75 million and were nearly triple the prior year’s totals.

Selling and marketing expenses grew by 28%, while general and administrative costs quadrupled and added more than $6.5 million in extra costs this quarter. As a result of these increases, income before taxes of just $53,000 was easily wiped out by income taxes of $2.18 million.

Should you buy MedReleaf?

MedReleaf saw a troubling increase in its operating expenses this quarter, and we’ve seen this even from Canopy Growth Corp. (TSX:WEED) back in its Q1 results, where its operating expenses tripled. We’ve seen many cannabis companies plagued by rising costs, with Aphria Inc. (TSX:APH) being one of the big exceptions.

Marijuana sales are growing, and as we inch closer to legalization day next year, the potential will only get bigger. However, we can also expect costs to get bigger as well, and it’s for that reason that investor shouldn’t turn a blind eye to rising expenses.

If a company is struggling to find profits now, then it could be even more difficult to do so when growth becomes exponential. For that reason, I would prefer to invest in a low-cost producer like Aphria which has a more disciplined income statement and focuses on efficiency and cost reductions.

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Fool contributor David Jagielski has no position in any stocks mentioned.

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