Millennials and Cannabis Stocks, The Aurora (ACB) Love Story – Smarter Analyst

Millennials and Cannabis Stocks, The Aurora (ACB) Love Story - Smarter Analyst
2 Billionaires Just Bought Aurora Cannabis Stock — Should You?
Although Aurora Cannabis (ACB) missed on their top and bottom-line estimates for Q3 2019, I believe these numbers do not accurately justify Auroras business. Analyst estimates had revenues of $67.5 million Canadian Dollars and predicted a loss of $52.6 million CAD. Aurora reported $65.2 million CAD for revenues and a $158.4 million CAD loss for the third quarter equating to an EPS loss of 16 cents.

To me, the more important numbers are derived from their cost per gram and their total production. Aurora has the goal of producing a gram of marijuana for $1/gram, which is crucial to achieving long term profitability. As for their total production, many have qualms over Aurora oversupplying the market and I will analyze if demand will be able to reach supply.

One major benefit of Auroras research with the UFC is that it is focused on high-margin products. For cannabis growers, two product areas are most profitable: CBD products and pre-rolled joints. By contrast, raw cannabis flower is comparatively cheap and low margin. Since Auroras partnership with the UFC is focused on CBD, any resultant products would be sold in one of the higher-margin cannabis market segments and could prove profitable for Aurora if they take off.

Why the Aurora Cannabis-UFC Partnership Is a Huge Deal

Aurora was able to decrease their cost per gram from $1.92 in Q2 2019 to $1.42 in Q3 2019. A 26% decrease in price/ gram is a considerable amount in only a few months and it conveys that the strategic acquisitions implemented by management are finally paying off. Management cites “economies of scale” being a reason for the decrease in price, but it is also attributable to their recent acquisitions. As we know, last quarter Aurora posted a large loss which was mainly attributable to a substantial increase in their goodwill. Some of these companies, such as Aurora Larssen Projects, BC Northern Lights, CanniMed Therapeutics Inc., HotHouse Consulting Inc., and Whistler Medical Marijuana Corporation all helped contribute to a lower cost per gram. This quarter Aurora produced 15,590 kg in Q3 compared to 7,822 kg in Q2, which represents a 99% increase quarter over quarter. If Aurora would have continued to produce their Q3 amount at $1.92, it would have cost $29,932,800, but instead, they only incurred a cost of $22,137,800 representing a saving of $7,795,000 in a single quarter. The ability to cut down costs is one of their goals to find long term profitability, which they seem to be achieving. Also, these savings are then magnified when looking at Auroras long-term outlook on production. They currently have the capacity for 150,000 kg and expect that they will have the capacity to produce over 625,000 kg per year by 2020. It is an ambitious goal, but they will have the help of new facilities.

The completion if the Aurora Sun is slated to be completed by mid-year 2020 and is stated to be able to produce over 230,000 kg per year. The Aurora Nordic 2 is then set for completion around the same time with expected production to be over 130,000 kg. The last considerable facility is the MedRelief Exeter which can produce 105,000 kg but Aurora does not give any indication to when it will become operational. These facilities alone will well over double the production capacity as Aurora hopes there will be a continued uptrend in demand for their product.

Its been a tough few months for Aurora Cannabis (NYSE:ACB) investors. After hitting a high point in April, the stock has been on a gradual but noticeable downtrend, following the companys most recent earnings report that showed high growth but missed analyst expectations. Although the companys sales jumped 20% quarter over quarter, its net loss was $150 million, showing the company is still a ways off from profitability.

As for continued growth in Auroras business, they increased their quarter on quarter revenues by double digits in their consumer and international medical divisions boasting an increase of 37% and 38%, respectively. Their Canadian medical revenues grew at a slightly slower pace of 8% with an increase in that customer base of 5%. According to Health Canada, the number of registered users is continuing to grow at a steady pace due to more widespread insurance coverage on medical marijuana. Last year, active patients grew 14.3% which is a good indicator for Aurora as their Canadian medical division is responsible for 45% of their total revenues.

Of course, the intended outcome of the Aurora-UFC partnership is to find applications for hemp-derived CBD oil or other products in sports medicine. Preliminary research has shown that CBD may be cardioprotective, meaning it helps strengthen the heart, and should this be proven conclusively, it would have obvious implications for sports medicine.

I also like to see that their international sales were able to grow at a substantial pace of 38% quarter over quarter proving that their strategic acquisitions and desire to become a global company are beginning to materialize. Another one of Auroras goals towards long-term profitability is leveraging their low per gram costs and create a first movers advantage in countries beginning to relax regulations regarding marijuana, specifically medical. According to a study by lift.com which had over 6,000 reviews of different marijuana products, Aurora had two of the top three most highly regarded brands and all of their brands scored within the top 11. The ability to produce a quality product at an affordable cost will surely entice new customers due to Auroras reputation for producing a quality product.

Another appealing aspect of this earnings report is the increased selling price of their cannabis extract division. This was another key component to Auroras long-term path to profitability as cannabis extracts have the highest gross margin out of any division. They boasted a 64% gross margin in Q3 in the medical division and 68% gross margin in their consumer division. As shown, they increased their prices from $10 to $11.01, conveying that there is demand for their high margin product and can increase the selling price per gram. As for the rest of the net selling prices, as a whole, they seemed to have decreased in every division except for the cannabis extracts. They all decreased in the single digits and this chance is more than offset by the reduction in production price.

Other areas where CBD is being researched include depression and anxiety, two conditions that may have a bearing on athletic performance as well. Assuming that Auroras research with the UFC sports medicine team is conclusive, it could result in patent-protected products that take off in the world of sports health.

Now, after highlighting some key aspects of this quarterly report, I will focus my attention on whether Aurora will be able to sell what it produces. As mentioned before, Aurora will have the capability to produce up to 625,000 kg by the end of 2020, but that does not mean they will sell, or even produce close to that amount. Currently, they have the capacity to produce 150,000 kg and if they grow production around 100% a quarter, which is a fairly close estimate to past quarterly growth, they will be producing 31,180 kg in Q4 2019, 62,360 in Q1 2020, and 124,720 in Q2 2021. This is a very crude justification for why they may need these extra facilities, but the broader question becomes if they will be able to have demand to meet production. In this most recent quarter, they outproduced demand by 6,430 kg or only sold 58.76% of their inventory. According to Auroras medical marijuana page, marijuana is good for up to 12 months kept at the right temperature. The demand is increasing, but it may take a couple of quarters for demand to catch up to production capabilities. Their reach into international markets increases potential customers exponentially as they are just developing a foothold specifically in the European and Mexican markets. Another promising metric is Health Canada believes that there will be an increased customer base in Canada of around 10% by 2021 as Aurora can hopefully leverage these customers to buy more of their products.

Although Auroras partnership with the UFC is presently focused on research, its possible that a number of branding benefits could come as a result, such as Aurora having its name mentioned on air during UFC broadcasts or branded Aurora products having UFC fighter endorsements.

In the very long term, a respected marijuana analyst from Cowen conveyed her view on the cannabis industry and stated that it could become an $80 billion industry. Estimates put the current industry at around $20 billion indicating room for about 3x growth. This is even on the low end as Tilray CEO claims that the industry could reach upwards of $150 billion, an extremely optimistic take on the industry. If we assume Aurora can increase market dominance in these new industries, Aurora will certainly not have a problem meeting demand in the future.

In the future, I believe that Aurora will be able to firmly establish itself as a global company and will be the benefactor of decreased global regulations of marijuana. Their ability to drive down the cost per gram shows that management is able to deliver on one of their main strategies to achieve profitability and conveys a sense of optimism towards their future decisions. In the short term, their overall production might look menacing, but Aurora is looking to the future possibility of potential customers and strives to be able to provide for future needs.

A version of this article originally appeared on The Motley Fool Canada site. For more coverage like this head to Fool.ca.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ACB over 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.

Recent Securities and Exchange Commission (SEC) filings show that Citadel Advisors and Renaissance Technologies, two investment firms run by multibillionaires, bought shares of Aurora Cannabis in the first quarter of 2019. Citadel Advisors is led by Ken Griffin, who has an estimated net worth close to $12 billion. Renaissances James Simon claims a net worth of more than $21 billion.  

Why did these billionaire investors buy Aurora Cannabis stock? And should you consider buying it, too?

Ken Griffins Citadel Advisors bought nearly $11.2 million of Aurora Cannabis shares in the first quarter. In addition, the investment firm bought call options for nearly 1.4 million shares, hedged by put options for a little over 1 million shares. Overall, Citadel upped its bet on Aurora significantly from the previous quarter.

The act would be the first piece of standalone cannabis legislation to pass Congress and would provide protection for banks that want to serve the cannabis sector in states that have legalized. The House version of the bill was approved by the Financial Services Committee in March and is expected to be approved when brought to a floor vote, which advocates are expecting to happen over the summer.

Jim Simons Renaissance Technologies initiated a position in Aurora in Q1, buying more than $7.1 million of the stock. Aurora is currently the only marijuana stock in the firms portfolio, unless you count Constellation Brands (NYSE: STZ), the alcoholic-beverage maker that owns 38% of cannabis producer Canopy Growth (NYSE: CGC). Renaissance held a direct position in Canopy Growth last year but later sold its shares in the Canadian company.  

Medical cannabis sales in Arkansas had a strong showing in their first week, according to Marijuana Business Daily. The state chalked up sales of more than 50 pounds of cannabis in nearly 5,000 transactions, exceeding those in Ohio, which has almost four times the population. Arkansas is expected to generate up to $20 million of sales in 2019, according to the 2019 Marijuana Business Factbook.

Citadel Advisors owns shares of several marijuana stocks in addition to Aurora. The firm currently has positions in cannabis producers Canopy Growth, Cronos Group (NASDAQ: CRON), and Tilray (NASDAQ: TLRY) as well as cannabis-focused real estate investment trust (REIT) Innovative Industrial Properties (NYSE: IIPR). Citadel also has a stake in Constellation Brands and tobacco giant Altria (NYSE: MO), which owns 45% of Cronos.

Separately, lawmakers are promoting the Strengthening the Tenth Amendment Through Entrusting States (STATES) Act, which would give each state the right to determine its own approach to cannabis legislation. That bill is backed by Elizabeth Warren and Cory Gardner, both Senate Democrats and presidential hopefuls, and Attorney General William Barr has said it is his preferred solution.

While SEC filings revealed that Citadel and Renaissance own shares of Aurora, the reports dont indicate why their billionaire leaders like the stock. But we can probably figure that out pretty easily.

Charlottes Web Holdings Inc. shares CWBHF, +2.49%  slid 2.6%, after the company reported a smaller profit for the first quarter than a year ago. The company said it had net income of $2.3 million, or 2 cents a share, in the period, compared with $3.1 million, or 4 cents a share, in the year-ago period.

Cowen analyst Vivien Azer used to view Canopy Growth as the best pot stock on the market. Earlier this year, though, she named Aurora as her top pick for three primary reasons. I suspect that those reasons were also instrumental in the decisions by Griffin and Simons to buy Aurora.

The major indexes were lower as concerns about the global economy and fears of a protracted trade war weighed on sentiment. A disappointing jobs report from Germany and Chinas threat on rare earth minerals — needed for all the gadgets of modern life — added to the downdraft.

At the top of Azers list is Auroras industry-leading production capacity. With demand outstripping supply in the Canadian adult-use recreational marijuana market, capacity is crucial. 

Revenue rose to $21.7 million from $13.1 million in the year-ago period. FactSet does not report enough earnings and revenue estimates from analysts to form a reliable consensus figure. Charlottes Web reiterated its full-year revenue guidance of $120 million to $170 million.

Over the long run, however, international medical cannabis markets will be much larger than the entire Canadian cannabis market. Its likely that Citadel Advisors and Renaissance Technologies paid especially close attention to Auroras international operations. The company is active in 24 countries and claims the highest international revenue right now. This arguably makes Aurora the leader in international medical cannabis markets.  

The stock will start trading on the Toronto Stock Exchange after delisting from the smaller Canadian Securities Exchange on May 30. The hemp company is allowed to trade on the TSX after hemp was made federally legal in the U.S. in last Decembers 2018 Farm Bill.

Another reason Azer liked Aurora that probably was also a factor for Griffin and Simon is Auroras relatively attractive valuation. Despite gaining nearly 70% so far this year, the companys market cap remains only a little over half that of Canopy Growth.

Tilray Inc. shares TLRY, -2.23%  fell 3.4%, Aurora Cannabis Inc. ACB, +0.55% ACB, +0.55%  was down 2.4% and Cronos Group Inc. CRON, +0.26% CRON, +1.56%  was down 3.9%.

Its never a good idea to buy any stock just because billionaire investors bought it. On the other hand, its not a bad idea to check out the stocks that major investors are buying to determine if theyre a fit for you.

MedMen Enterprises Inc. shares MMNFF, -4.11%  fell 0.1%, ahead of the release of quarterly earnings on Wednesday. Curaleaf Holdings Inc. CURLF, -1.78%  was up 1.5%.

Keep in mind that the investing styles of Citadel Advisors and Renaissance Technologies might be more aggressive than yours. If youre the kind of investor who prefers relatively safe and stable stocks, youll probably want to pass on Aurora.

Valens GroWorks Corp. VGWCF, +2.23% was up 4.9%, Organigram Holdings Inc. US:OGRMF was down 3.3% and Aleafia Health Inc. ALEF, -0.66% ALEF, -0.66%  was down 1.7%.

But investors who arent as risk-averse should find several things to like about Aurora Cannabis. The global cannabis market appears likely to grow tremendously over the long term. Aurora is without question one of the top leaders poised to benefit as this market expands.

The company also has other potential catalysts that could excite investors in the near future. Aurora tapped another billionaire investor, Nelson Peltz, to help line up partnerships with companies in industries that could be disrupted by cannabis. Canadas cannabis edibles and derivatives market is expected to open later this year, which could boost Auroras revenue growth. 

Consider the negatives for Aurora, though. The company isnt profitable yet and continues to spend a lot of money funding its operations and a flurry of acquisitions. Aurora also has a large number of convertible notes that will likely require it to issue a lot of new shares in the future, causing dilution in the value of existing shares.

Its also possible that international medical cannabis markets could take longer to take off than Aurora anticipates. This could leave the company with excess supply within a few years.

The bottom line is that Aurora isnt a good pick for some investors, but it could be for others. If it seems like a good fit for you, you definitely should copy billionaires Griffin and Simon in at least one way: Diversify. While both of the investment firms run by these men own significant stakes in Aurora Cannabis, the stock is only one of many spread out across multiple industries. They didnt become billionaires without managing risk effectively.

Keith Speights has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands and Innovative Industrial Properties. The Motley Fool has a disclosure policy.


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