Better Buy: Aphria vs. Aurora Cannabis – Motley Fool

Better Buy: Aphria vs. Aurora Cannabis - Motley Fool
Aurora Cannabis Should Make You Nervous
You might think that the choice between Aphria (NYSE:APHA) and Aurora Cannabis (NYSE:ACB) is an easy one. Aphria underperformed Aurora last year and has done the same in 2019 so far — and by a wide margin.

But theres a lot more to consider than just past stock performance in choosing between Aphria and Aurora. Which of these two Canadian marijuana stocks is the better pick now? Heres how Aphria and Aurora stack up against each other.

Its important to understand the reasons behind Aphrias relative underperformance. The company was hit by short-seller allegations in late 2018 that it drastically overpaid for LATAM Holdings in a transaction that benefited key Aphria insiders. Aphria also posted disappointing fiscal Q3 results in April.

But a review by a special committee made up of independent members of Aphrias board of directors found that the price Aphria paid for LATAM Holdings wasnt out of the ballpark of similar transactions made by its peers. Also, a change in the companys growing methods and initial packaging challenges with adult-use recreational cannabis hurt Aphrias Q3 sales. The good news is that these are all temporary issues.

Aphria appears to be in great shape from a production capacity standpoint. With its Aphria One facility now licensed, the company claims an annualized production run rate of 115,000 kilograms. Aphria is on track to boost its annual capacity to 255,000 kilograms.

It also is positioned to succeed in the Canadian adult-use market over the long run. Aphria secured supply agreements with all of Canadas provinces plus the Yukon Territory. The company teamed up with Southern Glazers, the largest wine and spirits distributor in North America, to distribute its adult-use cannabis products throughout Canada.

Aphria has operations in 10 countries outside of Canada with medical cannabis markets. The most important of these is Germany, where the company was one of three to be awarded a license to cultivate medical cannabis inside the country.

Perhaps the strongest argument for Aphria right now is that its valuation is more attractive than those of many of its peers. Aphrias market cap is well below that of most Canadian marijuana producers with similar production capacity. This could make the company more appealing to major players in industries that could be disrupted by cannabis that are looking for a cannabis partner.

Pretty much everything seems to be going right for Aurora Cannabis these days. Unlike Aphria, Aurora beat revenue expectations in its latest quarter. The companys future looks even brighter for several reasons.

Aurora continues to generate strong sales growth in the Canadian adult-use recreational cannabis market. But international medical cannabis sales are growing even faster. Aurora remains the industry leader in terms of total international sales. It was also, along with Aphria, one of the three companies to be awarded a license to cultivate medical cannabis in Germany.

The company also leads the industry in funded production capacity. While Auroras annualized production run rate currently stands at more than 150,000 kilograms, it expects to increase its capacity to more than 630,000 kilograms. Another big plus is that Auroras annual oil extraction capacity now stands at nearly 16,000 kilograms. This is especially important as the market for cannabis derivative products opens up in Canada later this year.

This tremendous capacity is also giving Aurora economies of scale that help it lower its costs. The company thinks that it will be able to get the production cost per gram at its Sky class facilities well below 1 Canadian dollar. Aurora expects to generate positive EBITDA in its current quarter by controlling costs while its sales soar.

Aurora doesnt have a partner from outside the cannabis industry like some of its peers do. However, that could change in the near future. The company brought billionaire investor Nelson Peltz on board in March as a strategic advisor to, among other things, line up potential partners in key industries that could be disrupted by cannabis. Peltzs connections in the consumer packaged goods (CPG) industry could be especially helpful.

Analysts view Aurora quite favorably because of all these factors. Cowens Vivien Azer particularly likes the companys significant production capacity, with demand exceeding supply in Canada and in international markets.

My view is that both of these stocks could perform well over the long run as the global cannabis market expands. Which is the better pick? I think the decision comes down to a couple of factors.

Auroras current production capacity is roughly 30% greater than Aphrias. But Auroras market cap is more than five times the size of Aphrias market cap. Aphria is also positioned well in the most important international markets where Aurora operates. My take is that while Aurora is arguably the stronger company, Aphria has more room to run and gets the nod as the better stock right now.

The company continues to build capacity that appears disjointed from global supply needs as competitors quickly ramp up supply.

For a company chasing a multi billion-dollar global industry, Aurora Cannabis (ACB) continues to spin wheels with decisions and statements that make me nervous. The company is still burning substantial cash and needs a big June quarter to get out of the hole. The oncoming supply flood remains problematic despite the claims of management, so my long-term investment thesis remains negative while cognizant that the stock can still rally in the short term.

For FQ3, Aurora Cannabis still hasnt made much progress in actually producing and selling cannabis, though most metrics did improve in the quarter. The company saw net cannabis revenue reach C$58.7 million, up from C$47.6 million in the prior quarter.

One might expect much larger sales from a company with a nearly $10 billion market valuation based on 1.1 billion shares outstanding. Not to mention, a company with an at-the-market offering for $750 million on the books.

In the quarter, Aurora Cannabis produced 15,590 kgs, but the company only sold 9,160 kgs. The amounts are still very minimal in comparison to the funded capacity of more than 625,000 kgs plus additional capacity from ICC Labs in Uruguay.

The first real test comes with Aurora Cannabis having 25,000 kgs available for sale in the current quarter ending in June. How the market absorbs all of this additional supply will be an initial first test of where the market goes.

The other tests include the additional supply from the company suggesting yields are 20% above targets. As well, a small competitor like CannTrust Holdings (OTC:CTST) is quickly moving from 3,014 kgs sold in Q1 with a goal of growing quarterly production to 75,000 kgs by the end of 2020.

The good news for investors is that Tilray (TLRY) sees supply remaining constrained for 18-plus months. CEO Brendan Kennedy was one of the few reasonable voices in the Canadian cannabis sector. On the Q1 earnings call, he had this to say about the sector:

We now believe there could be a supply balance in Canada in the next 18 months to 24 months as the market finds an equilibrium between supply and demand. This is longer than our estimate just eight weeks ago, as the industry continues to struggle ramping production in the existing regulatory environment.

The biggest promise maintained by management is the goal to reach EBITDA positive by FQ4. The company produced a C$36.6 million EBITDA loss in the last quarter so Aurora Cannabis has a huge step to make in the current quarter.

Due to a massive global expansion plan, the company has a relatively large operating expense base already. In FQ3, SG&A operating expenses were C$67.1 million, only up slightly from C$66.3 million in the prior quarter.

Management did an excellent job of maintaining SG&A costs in the prior quarter, but the company spends an absurd C$50.8 million on administrative costs. Aurora Cannabis spends a relatively small amount on sales and marketing for branding and research and development.

Even in a scenario of Aurora Cannabis becoming EBITDA positive in the June quarter, the company still spends over C$18 million on depreciation and amortization costs and almost C$40 million on stock-based compensation thats contributing to the massive share count growth.

So even if the large cannabis company reaches EBITDA positive, Aurora Cannabis will still have sizable losses and share count dilution. First though, the company needs to hit these targets to reach EBITDA positive.

Using some basic targets of limited pricing pressure and constrained operating expense growth to C$75 million would produce a big EBITDA boost:

The question is whether prices can stay anywhere near C$6.00 per gram, down from C$6.40 in the prior quarter. A more logical target is C$5.00 per gram.

If prices dropped about 6% QoQ with only about 2,000 additional kgs sold, whats going to happen when the amount explodes 170% in the current quarter to 25,000 kgs? Also, Aurora Cannabis plans to place some product in inventory for the consumables later this year so sales might fall short of the 25,000 kgs.

The production level will quickly expand again to 37,500 kgs per quarter for a ~300% increase in just two quarters. The difference here from the growth in 2018 is that these levels are going to be very material amounts.

The risk remains that prices drop more toward C$4, pressuring gross margins and ultimately keeping the company losing money and struggling to reach EBTIDA positive. What makes me nervous is these ultra bullish comments on demand from CEO Terry Booth on the earnings call:

I think I said last quarter that if there is one thing that I lose sleep about is our ability to supply the global demand for cannabis. But it is definitely something that still is at the top of our agenda, increasing our capacity to feed the global need. It took Canada five years to meet its demand for the population 33 million. So you just put that math into perspective with the EU, with Australia, Mexico and other countries that are coming online, it would take nearly 50 years to meet that demand. But we are not going to take that long because of the scale, we are now able to build upon.

The CEO seems to miss that relatively small companies like CannTrust are in the market boosting supplies 25-fold as well. Aurora Cannabis doesnt need to supply the global markets alone and possibly at all to meet future demand.

Aurora Cannabis can argue all day that the company has lower production costs, but such a position wont stop other companies from loading up supply to meet this demand as well. Making a statement suggesting a simple company in Canada needs to supply the global supply or it will take 50 years to feed the need already served by an illegal market just sounds tone death.

The key investor takeaway is that Aurora Cannabis is increasingly making us nervous that the company is blind to the oncoming flood of cannabis supply. The company appears far too bullish on the pricing environment under this scenario.

If were right, this market doesnt end well for the stock. Tilray is pointing to a market that might hold up longer than expected, but any long position is just for a short-term trade.

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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.


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