Why Aurora Cannabis Bounced Back Today

Why Aurora Cannabis Bounced Back Today
3 Ways Aurora Cannabis Completely Fooled Investors in Its Q1 Report
Management has a strong track record of striking attractive deals which have created a first class vertically integrated platform.

The company is poised to show very strong growth from both medical and recreational cannabis in Canada and global markets where it already has a presence.

Aurora Cannabis (ACB) has had an impressive ascension. In just the past 4 years, the company has gone from being an obscure Canadian OTC stock to an NYSE-listed stock with a multi-billion dollar market cap. In this article I will trace the companys rise and summarize where I see the market opportunities.

Aurora was founded in 2013 and its stock began trading in Canada in 2014. In 2015, the company received its licenses to cultivate and sell cannabis in Canada. Starting in 2016, Aurora began a series of aggressive M&A transactions which enabled it to gain massive scale. To date, Aurora has announced/completed 15 acquisitions and 12 strategic investments.

Aurora has largely used its richly traded public equity as currency to complete deals. This has served the company well because equity has been easy for the company to raise and targets have been more willing to take equity in their deals in order to share in the upside of growth in the industry.

The above chart shows a timeline of recent acquisitions and strategic investments the company has made. Of particular note are the CanniMed and MedReleaf acquisitions. CanniMed and MedReleaf were both large publicly traded companies which significantly increased ACBs scale.

In November 2017, Aurora announced an all-stock hostile take-over for CanniMed which was rejected by CanniMeds board. After some back and forth CanniMed eventually agreed to the deal. In May 2018, Aurora agreed to buy MedReleaf for $2.5 billion in an all-stock deal.

Both the CanniMed and the MedReleaf deals show that Auroras management team is capable of taking down sizable transactions. It is particularly impressive that Aurora got the CanniMed deal done considering that it was a hostile takeover at one point. Reading through the list of the other deals Aurora has structured shows that management are savvy deal makers that know how to structure incentives with cash offers, convertible notes, and earn-outs.

To managements credit, the company has been able to assemble an impressive platform quite quickly. Today the company counts 11 cultivation facilities capable of over 500,000 kg in annual production capacity, some of this capacity is still under construction but is expected to come online by H1 2020. Aurora is now an industry leader in terms of revenue and production capacity.

Today Aurora Cannabis mostly serves the market for medical marijuana. Aurora primarily has operations in Canada but currently services nearly a dozen international markets. In the companys October 2018 investor presentation, Aurora estimated the market size of the Canadian medical market at $9 billion per year and the global medical market at 180 billion per year.

Aurora plans to continue using Canada as its primary location for growing and packaging its products, but over time the company seeks to build a large export business globally through third party wholesalers. In Europe, which is currently the largest global market for medical marijuana, Aurora has partnered with Pedanious, Europes largest distributor of cannabis, for distribution. Over time, Aurora will seek more country approvals to sell its medical product, boosting its revenue growth. For example, in October 2018, Aurora received approval to ship its products to Poland.

The other large market opportunity for Aurora is the recreational market in North America. This year, Canada passed a law making recreational use of marijuana legal. It is a bit early to know just how large of an immediate opportunity this will be for Aurora because legal sales did not begin in Canada until October 2018. Canadas Parliamentary Budget Office estimates that the recreational cannabis market is between 4.2 and 6.2 billion Canadian dollars per year.

Although legalization for Canadian recreational use occurred after the last quarter end, Aurora gave positive commentary on their November 13, 2018, earnings conference call.

Lets briefly talk about our successes in the Canadian adult consumer market, which began on October 17. This was a major milestone, and Aurora is pleased to be one of the strongest participants… Aurora was well prepared for adult consumer use, having strategically built substantial inventory that enabled us to meet just about all of our supply obligations… While its still early days, were able to report that Aurora has had some of the most popular strains and brands in the system.

The commentary from the call was very encouraging. Not only has Aurora placed their bets on the right assets in the industry to benefit from both increased medical use and legalization, but the company also seems to have nailed the timing in terms of being prepared with inventory and production capacity investments as demand soars.

Finally, although Aurora does no business in the United States today, the company would also benefit from wider scale cannabis legalization in the US. Aurora is already developing a strong export strategy and relationship with international distributors. According to the Marijuana Business Factbook, U.S. Cannabis retail sales could reach $22 billion by 2022. There could be upside to this estimate if more states legalize Cannabis than are currently expected to. At this point, we have seen states legalize or relax lax one at a time like falling dominoes. Although I have not seen any credible estimates on when we could see broader legalization at the federal level in the United States, it appears to be inevitable. If that hypothesis turns out to be true, we should expect Aurora to enter the U.S. market either through an export/distributor strategy or through M&A.

Aurora has had an extremely interesting rise through savvy deal making and good timing. I give the management team a lot of credit and expect them to continue executing on their strategy of aggressive deal making to secure their place as an international leader in medical and recreational cannabis.

We are still in the early days of Cannabis legalization for recreational use in Canada where Aurora already appears to have a strong market share. While the company currently doesnt have much in the form of revenue and earnings to show, growth should be extremely robust in the coming years. I am not yet sure whether the valuation of the stock is justified by the future growth, but I will continue learning about the cannabis space and plan to report back in a future article.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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The green rush is in full swing in our neighbor to the north. Just under a month ago, Canada lifted the curtain on nine decades of recreational marijuana prohibition and opened its doors to the fast-paced cannabis industry. When fully up to speed, Canadian pot stocks are expected to benefit from in the neighborhood of $5 billion in added annual sales.

Now, with adult-use weed legal, all eyes have turned to marijuana stocks for tangible results. After all, prior to legalization it was really a race to see which pot stock could promise the most production or forge the greatest number of supply deals. Now we find out whether or not marijuana stocks can deliver on their lofty goals.

Earlier this week, whats arguably the most polarizing pot stock of them all, Aurora Cannabis (NYSE:ACB), reported its first-quarter operating results. As you might have expected, strong growth was readily apparent throughout. 

Total sales for the quarter hit 29.7 million Canadian dollars, up 260% from the CA$8.2 million reported in the year-ago quarter. Even sequential quarterly growth was impressive, with sales rising 55% from Q4 2018 (an approximate CA$10.5 million jump).

What really caught the attention of Wall Street and investors was the companys gross margin and bottom-line improvement from the year-ago quarter. Gross margin on cannabis sales jumped 70% in Q1 2019 from 58% in Q1 2018, which was a function of higher net selling prices for dried cannabis and lower cash costs to produce dried flower. More importantly, earnings for the quarter leaped to CA$105.5 million (not a typo), which represents a 2,862% year-on-year increase. On an adjusted per-share basis, were talking about $0.12 in EPS.

Although Aurora Cannabis stock declined modestly by market close following its earnings release (which can be at least partially blamed on the stock markets broad sell-off), its pretty clear that, at least in the early morning, investors were pleased with what they saw. As a company thats capable of perhaps 700,000 kilograms in annual output, Auroras leading position as a producer and its rapidly growing sales make it a stock that investors tend to flock to.

However, if you didnt take the time to comb through Auroras first-quarter operating results, you were possibly fooled on a number of fronts.

To begin with, even though Aurora Cannabis headlined with a CA$105 million profit, the company wouldnt have fared so well without a number of one-time benefits.

Examining its income statement filed with SEDAR (Canadas regulatory agency thats essentially its Securities and Exchange Commission), Aurora had an CA$85.8 million unrealized gain on derivatives, and a CA$144.4 million gain on the “disposal of significant influence investment” (i.e., a realized gain from its investment in The Green Organic Dutchman). These two substantive gains were responsible for pushing Aurora decisively into the black in the first quarter.

However, if you were to look at the company from a purely operating perspective, Auroras quarter was ugly, at best. It did generate CA$29.7 million in sales, but it also reported CA$9.5 million in cost of sales, CA$35.9 million in general and administrative expenses, CA$29.4 million in sales and marketing costs, CA$15 million in acquisition costs, CA$21 million in share-based payments — and the list goes on. Even factoring in its fair-value adjustments on biological assets, Aurora reported a CA$111.9 million loss from operations in the first quarter.

Secondly, you should understand that aside from tossing around big production figures and monumental sales growth, Aurora Cannabis isnt producing like a top-tier grower as of yet.

Sure, the company nearly quintupled the amount of cannabis it produced from the year-ago quarter, and more than doubled production on a sequential quarterly basis. But at the end of the day, it yielded just 4,996 kilograms, which extrapolates out to 20,000 kilograms a year. Even with the company suggesting in its Q1 report that it has a run rate of 70,000 kilograms per year, thats still a far cry from its projection of 570,000 kilograms at peak capacity, prior to the announcement and completion of its ICC Labs acquisition. With ICC Labs, were probably at closer to 700,000 kilograms of annual output.

With a market cap of $6.6 billion, and as a projected top-tier producer, investors might be enamored by the companys potential. But lets be clear: Its not producing anywhere near its peak potential. Its going to take a lot of time — and investor patience — before Aurora really begins to ramp its production.

Lastly, with legalization having occurred just over four weeks ago, investors might be seeing things that simply arent there.

For instance, yes, Aurora Cannabis did report 260% year-on-year sales growth. However, this sales growth was almost entirely tied to the medical cannabis market or ancillary businesses associated with the adult-use market.

During the first quarter, CA$24 million of the CA$29.7 million in sales was derived from the medical cannabis market. The remainder came from other segment services (CA$1.4 million), analytical testing services (CA$0.4 million), patient counseling services (CA$1.2 million), design, engineering, and construction services (CA$1.5 million), and… oh yeah… adult-use revenue ($0.6 million). Thats right. Just a measly CA$553,000 in sales for the entire quarter was directed at the recreational market.

Now, to be fair, the quarter ended on Sept. 30, 2018, which didnt encompass the legalization that occurred on Oct. 17. However, its disappointing that so few adult-use market sales were recognized to provinces and retailers in advance of legalization.

Ive been hypercritical of Aurora Cannabis previously, and I stand by that criticism until proven wrong. For the time being, its a company thats losing a lot of money on an operating basis and has a long way to go to be a true industry leader. It has also drowned its shareholders with share-based acquisitions and bought-deal offerings. For this investor, at least, its a marijuana stock you should avoid.

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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