Heres What Aurora Cannabis Will Look Like Following Its ICC Labs Acquisition

Here\s What Aurora Cannabis Will Look Like Following Its ICC Labs Acquisition
Cannabis shares light up as U.S. voter support for industry grows
NEW YORK (Reuters) – Shares of cannabis companies rose on Wednesday as results from the previous days U.S. elections pointed to more favorable political conditions for the cannabis industry.

Tilray Inc <TLRY.O> shares jumped 30.6 percent. Shares of New Age Beverages Corp <NBEV.O>, which has previously announced intentions to expand into cannabis products, climbed 20.1 percent. U.S. shares of Canadian companies Canopy Growth Corp <CGC.N> <WEED.TO>, Aurora Cannabis Inc <ACB.N> <ACB.TO> and Cronos Group Inc <CRON.TO> <CRON.O> rose between 8 and 10 percent. The ETFMG Alternative Harvest ETF <MJ.P> posted a 7.1 percent gain.

Trading volume for the stocks was also brisk. Volume for shares of Tilray, whose volatility has served as a bellwether of investor sentiment toward the cannabis industry, was more than four times its 10-day moving average.

Cannabis shares initially rose upon the passage of ballot initiatives in several states approving marijuana use. Michigan became the 10th state to approve recreational use of marijuana, while Missouri and Utah passed measures to legalize medical use of the drug. A measure to approve recreational marijuana use in North Dakota failed, however. The drug remains illegal under U.S. federal law.

“Theres a number of major steps to go through for the industry to develop the potential that is there,” said Tom Plumb, portfolio manager at Wisconsin Capital Management in Madison, whose holdings include Canopy Growth. “Its going to be in the best interest of government to basically get handles on this industry.”

The stocks added to their gains, with Tilray shares hitting a session high, after reports that U.S. Attorney General Jeff Sessions was fired. Sessions, an opponent of marijuanas legalization, had given prosecutors a greenlight to aggressively enforce federal laws against the drug in states where it had been decriminalized.

Despite the stocks rally, Sessions departure likely has little impact on the cannabis industry, said Jordan Waldrep, senior portfolio manager at USA Mutuals in Dallas, whose holdings include Canopy Growth, Aurora Cannabis and Cronos Group.

Nonetheless, Waldrep said, the passage of state initiatives and general voter sentiment indicate growing momentum for the cannabis industry.

“Its showing us the trend of voter opinion,” he said. “Theres no putting the genie back in the bottle on this one.”

Sentiment is turning in marijuanas favor internationally. Mexicos next interior minister, Senator Olga Sanchez, told Reuters that a bill would be presented this week that would permit companies to grow and commercialize marijuana.

Two senators, Colorado Republican Cory Gardner and Massachusetts Democrat Elizabeth Warren, have sponsored a bill that would leave determining the legal status of marijuana to states, thereby shielding cannabis companies from federal prosecution.

Also, two narrower bills regarding marijuana could be viable, especially as the Democratic Party takes control of the House of Representatives, according to analysts at Cowen & Co. The Safe Act would permit banks to provide services to cannabis companies in compliance with state law. The Veterans Equal Access Act would allow doctors in the Department of Veterans Affairs to authorize medical cannabis for patients in states where such use is legal.

“Broadly speaking, this election is less transformative for cannabis than the 2016 election by virtue of the fact that there were fewer ballots at the state level,” said Vivien Azer, an analyst at Cowen. “But the expectations are higher, federally speaking, as it relates to the makeup of Congress.”

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The marijuana industry has truly been something to marvel at this year. Although weve witnessed plenty of highlights, including Vermonts legalization of recreational cannabis entirely through the legislative process and the first cannabis-derived drug getting the thumbs-up from the U.S. Food and Drug Administration, its the legalization of recreational marijuana in Canada thats stolen the show.

Following years of promises from Prime Minister Justin Trudeau and months of debate in the Senate, Canada officially legalized adult-use weed via the Cannabis Act on Oct. 17, 2018. Now that Canada has become the first industrialized country in the world to do so, Wall Street is expecting its pot industry to eventually generate $5 billion or more in added annual sales atop what it was already bringing in via medical cannabis sales and exports to foreign countries. Its this major opportunity thats enticed marijuana growers to expand their production capacity as quickly as possible.

Perhaps no marijuana stock has taken this to heart more than Aurora Cannabis (NYSE:ACB). Aurora, which recently uplisted to the New York Stock Exchange from the over-the-counter exchange, began the calendar year with the expectation of growing just over 100,000 kilograms of cannabis at peak capacity. This was to include its state-of-the-art Aurora Sky facility, with its projections for around 100,000 kilograms, along with Aurora Vie and other smaller facilities adding icing on the cake, so to speak.

Then, beginning in January, Aurora Cannabis got very aggressive on the partnership, organic construction, and acquisition fronts, and it hasnt looked back since. Listed in no particular order, the company:

According to the companys most recent quarterly operating results, this combination of organic builds, partnerships, and acquisitions is expected to yield 570,000 kilograms of production when running on all cylinders. By comparison, Canopy Growth Corp. and Aphria are the next-closest competitors, with estimated annual output of around 500,000 kilograms and 255,000 kilograms, respectively. This means that Aurora Cannabis is currently in the drivers seat in terms of peak annual production.

Of course, the company isnt done just yet. On Sept. 10, it announced plans to acquire all outstanding shares of South Americas ICC Labs (NASDAQOTH:ICCLF) for 1.95 Canadian dollars, or CA$290 million. While far from the largest transaction in the cannabis space, itll possibly border on being the third deal for Aurora in the top 10 largest deals in the cannabis space by market cap in history. This past Tuesday, Nov. 6, ICCs shareholders voted in favor of the buyout, paving the way for closure of the deal. 

What is Aurora Cannabis buying exactly? First off, it gives the company a uniquely large presence in a handful of key South American markets. ICC Labs currently has approximately 70% market share in Uruguay, the only other country in the world where recreational marijuana is legal. It also holds licenses in Colombia for medical cannabis production.

ICC Labs also brings product diversification to the table. Uruguay is the only country in the world at present that allows licensed producers like ICC to grow cannabidiol- (CBD-) rich hemp at large scale. CBD is the nonpsychoactive component of the cannabis plant best known for its perceived medical benefits. Cannabidiol is traditionally targeted at medical patients and, as such, usually boasts better pricing power and margins than dried cannabis flower.

Auroras acquisition of ICC Labs also introduces much needed infrastructure. ICC has been in the process of constructing a large-scale extraction facility for some time now thatll be able to process 150,000 kilograms of CBD feed per year when complete. Its expected to be fully operational by the end of this calendar year.

And, most importantly, ICC Labs brings a lot of added capacity. It already has 92,000 square feet of existing cultivation space, with two additional facilities under construction: a 124,000-square-foot greenhouse in Colombia and a 1 million-square-foot facility in Uruguay. Combined, thats 1.2 million square feet that could, conservatively, add 100,000 kilograms of extra production potential each year.

Altogether, by 2021, assuming its projects remain on track and the company is able to receive all necessary cultivation and sales permits, Aurora Cannabis may be nearing 700,000 kilograms of annual production. Taking into account the economies of scale that come into play with an operation this size, Aurora could be a dominant force within the cannabis space. 

Of course, theres more to being a successful marijuana stock than simply outproducing your peers. Investors would be wise not to be overly enamored with Auroras peak production estimates for two particular reasons.

First, youll have to understand that Aurora is still a long way away from hitting its peak production target. During the companys fiscal fourth-quarter report, released on Sept. 24, it suggests that itll only be producing at an annual run rate of 100,000 kilograms by the end of calendar year 2018 and perhaps 150,000 kilograms a year by the end of fiscal 2019 (June 30, 2019). Thats a far cry from its peak potential.

In the meantime, this is a company thatll be spending a lot of money constructing greenhouse facilities, building up its brands, and laying its international infrastructure. In other words, its a recipe for exceptionally high near-term costs, which should translate into unwelcome losses, even with surging sales.

The second concern with Aurora — which has been a problem for some time with most pot stocks — is the companys ballooning outstanding share count. In order to fund its numerous acquisitions and construction projects, Aurora has almost exclusively turned to bought-deal offerings. A bought-deal offering involves the sale of common stock, convertible debentures, stock options, and/or warrants in order to raise capital. These offerings could very well push its outstanding share count to north of 1 billion shares from 16 million just over four years ago. This weighs on the value of existing shares of the stock, as well as makes it that much tougher for Aurora Cannabis to produce a meaningful per-share profit.

Make no mistake about it: Aurora Cannabis has intrigue. But its best left on the sidelines by investors until its bottom line matches already-lofty expectations.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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