Anyone hoping for more details on a potential partnership with a major company outside the cannabis industry came away disappointed after Auroras Q3 update. In March, Aurora announced that it had signed up Nelson Peltz as a strategic advisor. Peltz is the CEO of multibillion-dollar investment firm Trian Fund Management. He has extensive ties in the consumer packaged goods industry.
But Aurora didnt provide any new information in its Q3 conference call on how the hunt for partners is going. Some might have even gotten the impression that Chief Corporate Officer Cam Battley was downplaying the search for a partner somewhat, with his statement that Aurora is working with Peltz “on multiple initiatives, including our partnership strategy.”
Tilray CEO Brendan Kennedy stated in his companys quarterly conference call that Tilray “has been inundated with contacts from Fortune 500 companies who are interested in exploring partnerships” with the company. So far, we have no idea how many companies Aurora might have talked with about potential partnerships or how far any of those discussions have progressed.
Speaking of Tilray, its already in the U.S. hemp market thanks to the recent acquisition of Manitoba Harvest. Canopy Growth is building a large-scale hemp production facility in New York state and expects to have hemp CBD products on the market by the end of the year. However, we still dont know what Auroras plans for entering the U.S. are.
Aurora Cannabis CEO Terry Booth said in the Q3 conference call that his company “is not being blind to whats going on in the United States.” He noted that Auroras spin-off company Australis Capital is doing deals in the U.S. and that Aurora has rights to buy a significant stake in the company in the future. But Booth added that Auroras strategy to enter the U.S. market is “confidential.”
Aurora currently can produce around 150,000 kilograms of cannabis on an annualized basis. The company is busy ramping up capacity even more.
During Auroras Q3 conference call, Cowen analyst Vivien Azer asked Battley about the rationale for building up so much production capacity when there could be an oversupply situation over the long term. Battley replied that Aurora doesnt “see any shortage anytime soon.” Booth said he still loses sleep over being able to supply enough cannabis for the global market.
The reality, though, is that we simply dont know at this point whether Auroras big bet on capacity expansion will pay off anytime soon. If international medical cannabis markets dont grow as quickly as expected, Aurora could have more capacity than it needs.
It looks as if Aurora is on track to achieve positive EBITDA in its fiscal fourth quarter, which ends on June 30. But positive EBITDA doesnt mean Aurora will be profitable. Theres still a big question for the company regarding how much additional dilution might be on the way.
This isnt a minor issue. Aurora has been the biggest diluter in the value of existing shares in the Canadian cannabis industry. Last month, the company announced that it had filed the needed regulatory paperwork in the U.S. and in Canada to raise up to $750 million by issuing new securities.
Canopy Growth doesnt have to worry about this problem thanks to the huge cash infusion it received from partnering with Constellation Brands. But Aurora doesnt plan to give up an equity stake with any partnership deal it might make.
I think Aurora has demonstrated that its on the right track both in the Canadian and international markets. However, I also suspect that the companys unanswered questions are holding the stock back to some extent.
Yes, I know Auroras shares have soared more than 70% so far this year. But I think the companys market cap could be much closer to that of Canopy Growth if investors were confident about Auroras partnering strategy, its U.S. expansion plans, its capacity expansion, and its capital needs.
The future appears to be bright for Aurora. But, in my view, the sooner the company can provide answers to the open questions, the better off it — and its shareholders — will be.
Keith Speights has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.
Although the quarterly results for Aurora Cannabis (ACB) were decent, the focus on sales of recreational pot, as usual, obscured the real potential of the industry in general, and Aurora specifically, which is far ahead of its competitors at the international level.
In this article I want to focus on the immense short- and long-term potential of the global cannabis market for Aurora, the specific markets that will lead the way in the near term, why the U.S. isnt as important for now as some suggest, and why investors should focus primarily on medical cannabis instead of recreational cannabis.
When looking at the figures in the latest earnings report for Aurora, a cursory glance at sales results from overseas markets appear to be somewhat anemic in relationship to the overall revenue of the company. After all, as Ive mentioned a number of times, the company has a presence in 24 countries, and it would seem that it would be able to generate significant sales from those markets.
According to the companys figures, Aurora sold C$4 million in dried cannabis to the EU. While that was 40 percent above the prior quarter, it wasnt exactly inspiring if you dont understand where the company is in the process of building out those markets. As a whole, it only accounted for under 7 percent of revenue in the reporting period.
There is nothing wrong with what Aurora is doing with its international expansion. All thats happening is its putting the various pieces of its production and distribution network together. When thats in place, the revenue is going to soar, as well as earnings, from these higher-margin markets. The good news is this isnt very far away, according to management. Thats important to consider because the timing of its production ramp-up is coinciding with the pace of putting the infrastructure in place that will fuel meaningful growth.
Without a doubt the most important EU market at this time, and certainly for many years, is Germany. Not only is it because of the potential size of the cannabis market there, but also because the potential medical market, according to Aurora management, is approximately 850,000 in the “very short term.”
Another key factor is many patients also receive medical coverage for cannabis, making it a fairly predictable market to compete in, once customers are won.
Aurora reached the 850,000 figure by using the Canadian market as a baseline, where over 1 percent of the population uses medical cannabis. Also, the figure above represents the German market alone, not the entire EU market. The inclusion of insurance coverage in Germany will accelerate the growth and adoption rate to very high levels.
Supply constraints have been a temporary issue, but with the company projected to have somewhere near 400,000 kilograms produced in Canada alone, it should have no problem supplying Germany and other EU markets for many years into the future. By 2020 it should have well over 600,000 kilograms of cannabis production around the world that is available for sale. It has the capacity for a lot more if it is needed.
The recent win in the public tender competition in Germany, where it received the highest ranking among 79 applicants, further reinforced its position in this important market.
As a result, Aurora will be able to supply a least 4,000 kilograms of medical cannabis in that market over a four-year period. Bear in mind this isnt a limitation in regard to imports, but reflects domestic production. First shipments from the facility that construction is scheduled to launch this month, will start in October 2020.
Another positive in this deal is it provides Aurora a domestic foothold in case there are ever restrictions on cannabis imports put in place.
In the near term, outside of Canada, Germany appears to be the market that will have the most impact on the performance of the company. This should dramatically boost the revenue and earnings of Aurora going forward.
Using the Canadian market as a proxy, the company sees the need for a lot more capacity to meet the soaring demand for medical cannabis in global markets. Supplying the German market is important because its the largest market in Europe, and by gaining success there, the brand of Aurora will gain recognition and trust across the continent.
The second most important medical cannabis market for the short term is Australia. CEO Terry Booth noted that it has gone from under 500 patients in 2018 to over 5,000 now. Since Australia doesnt have any production facilities at this time, itll be dependent on imports for a long time.
One final word on the EU market. A lot of investors arent aware that the EU is a far larger market than the U.S., even though much of the media coverage is associated with cannabis companies finding ways to enter or position themselves in the U.S.
Not only does the EU combined have a lot more people in the U.S., with approximately 500 million, its also the largest economic bloc in the world as well.
So while the U.S. market is important and interesting, as usual, Aurora is allocating time and resources to the most immediately important growth sectors of the global cannabis market.
Having stated that the EU in size and potential is more compelling than the U.S. market, that isnt to suggest the U.S. isnt important to Aurora, because it is. Even so, there are enormous challenges in the U.S. besides the obvious illegality of pot at the federal level.
Right now, they have multiple state operators, multi-state operators that have small facilities in their various states. And thats not really the Aurora way of doing things. And if we do go to the states, we will be focusing on large populations that are not fully established that have regulations that we are able to operate in with profit. If they erase the state lines, that whole picture changes. If you are able to cross those state lines, then it becomes a massive cannabis market.
Cam Battley said something very interesting in relationship to importing product into the U.S. whenever cannabis is legalized by the federal government.
“We have a strategy of entering into the U.S. and that strategy is obviously confidential. But I would expect, if we have an over capacity in Canada and the rest of the world, we would love to ship to the U.S. But I dont think we will have that capacity depending upon the timing. Even if they announced that they are going to have a legal system, it would take years to get the regulations in place and proper capacity in place.”
There are two major takeaways from his comments. The first is that Aurora doesnt need to U.S. under its current production capacity plans to sell cannabis. Thats another way of saying its domestic market and international sales outside the U.S. will take up the bulk of its supply. This is an extraordinary statement as to its demand for global demand.
While many financial outlets point to the lack of a visible U.S. strategy as a negative, once again the company turns logic on its head and reveals it already has end markets for its vast production capacity. I dont think most investors or the general market understand how quickly demand for cannabis around the world is climbing.
Another element of the overall U.S. cannabis market as it relates to Aurora is that while the company has no plans at this time to export to the U.S., Cam Battley did give a general glimpse into the thought processes of the company. “The other thing to emphasize is once the opportunity exists to build production in the U.S. for us, we build the best cannabis production facilities in the world. I think we have clearly demonstrated that with the highest efficiency, use of automation and technology that nobody else has thus far been able to touch. And the result of it is premium product at a real economical cost. So once the opportunity exists, you can expect that we are going to be looking at using our technological lead to build that capacity ourselves in countries around the world.”
The point hes making there is Aurora is so far ahead of its competitors in the quality, productivity and efficiency of the facilities it builds, that building them in various markets is competitive advantage that cant be matched at this time. That means larger harvests per square foot and lower costs.
It also means lowering exposure to risk if countries decide to lower the allowable amount of imports into their various respective markets.
With a lot more potential to add capacity, if Aurora needs to ramp production quickly because of soaring demand from the U.S. market after legalization, it already can add about 200,000 to 300,000 more kilograms on an annual basis with its existing holdings (beyond the projected 600,000 kilograms-plus per year it plans on having in place within a year or two).
But since its already said it prefers to add facilities within the boundaries of different countries, its probable they will go that route before taking the time to increase production capacity in Canada, as it relates to the U.S. market.
The most probable scenario is it will take any excess supply and use that to help meet U.S. demand, while building facilities within the country.
I dont think the market quite understands the implications of what Aurora management stated. Essentially, theyre saying that even without the U.S. its production capacity has enough demand around the world to boost revenue and earnings growth for years.
So while the idea it must have a U.S. presence to compete with its peers sounds legitimate, in fact within its current capacity strategy, it has more than enough demand to meet its goals.
That of course doesnt mean Aurora isnt interested in the U.S. market, only that its waiting to see first, when cannabis is legalized federally, and second, how that plays out on a state-by-state basis. As it stands today, it appears Aurora is looking at how to play markets in specific, strategic States, rather than try to force its way into a market thats even more difficult than Canada and its provinces. As the company noted:
Is it going to be legalized medically state to state or adult usage state to state all at once? We dont know. Nobody knows. And I dont think the government knows. So thats a ways away. Its one step at a time and we are taking the steps necessarily to do that in an organized fashion.
Thats another way of saying theres a lot of time to prepare for whatever direction the U.S. government takes in regard to cannabis. Those that are making a big splash in the media as a result of the perception theyre being aggressive concerning the U.S. market, in my opinion are doing so because theyre so far behind Aurora at the international level. They know there isnt going to be much in the way of revenue and profits for a long time in the U.S., but they are positioning themselves as leaders there, when in fact it will have little impact on the performance of companies outside of the U.S.
In the end, the most important markets for Aurora in the world are Canada, Germany, Australia, and a few other countries in the EU, such as Italy. These will drive growth for the company far into the future.
Last, its demand for medical cannabis that is driving global demand, and even though recreational pot gets the majority of news headlines, its the least desirable of all the segments of the cannabis market because of it being a commodity and a low-cost product that lowers margins and puts downward pressure on earnings.
Aurora is gearing up to compete in the international medical cannabis market, and I believe its positioned to blow past all its competitors, who are still struggling to gain market entry, let alone starting to sell to them as Aurora is now ready to do. This is far more important to take into consideration than a one-off earnings miss.
Disclosure: I am/we are long ACB. 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.