Some analysts forecast the cannabis industry will generate $200 billion in sales in the next ten years. In 2018, that number was $12 billion. With so much money to be made, new companies are popping up like weeds to compete for investor dollars. In fact, the most recent update to the Robinhood index showed four cannabis stocks (Aurora Cannabis, Cronos Group, Canopy Growth, and Hexo) among the top 20 with Aurora Cannabis in the top spot. This suggests that younger investors are buying into the growth in this industry. But as much as the cannabis industry is not going away, the market is still finding its feet. That’s why it’s important to look at both the pros and cons of owning ACB stock.
A noisy industry is a volatile industry
The cannabis industry is very noisy. Remember when you were in school and the entire class was punished because one student did something wrong? That’s essentially what happened to Aurora Cannabis and other cannabis stocks when CannTrust Holdings (NYSE:CTST) was punished by regulators for growing cannabis in unlicensed rooms. This is not to imply that CannTrust’s violation was trivial, it may result in them losing their production license. However, investors got spooked and dragged the price of the entire sector down as they reconsidered valuations. Even though the issue with CannTrust does not really affect Aurora or any of the other major players such as Canopy Growth or Cronos, the violation by CTST was the primary reason ACB’s stock price declined by over 13% in July.
The question for investors is whether such a steep decline was justified, and that’s where you have to look at the fundamentals for Aurora to see if the stock price is justified.
Positive: Aurora is the leading cannabis producer
Aurora Cannabis (NYSE: ACB) is an established producer that stands to gain from the industry’s explosive growth. In terms of peak production capacity, Aurora is Canada’s leading producer. The company was producing at a rate of 150,000 kilos in March of this year and was suggesting that by the end of their 2020 fiscal year (which will occur on June 30, 2020) they will increase their output to at least 625,000 kilos with an output exceeding 700,000 kilos when all 15 of its farms become fully operational. What makes Aurora’s market position even more enticing is the economies of scale that should give ACB’s margins a boost. As more, and larger, farms become operational, the price per gram for marijuana should decline.
Positive: Supply problems seem to be clearing up
One of the challenges of investing in cannabis stocks is that there are so many unknowns in the industry. One of those unknowns at the moment is regulation. Health Canada, the governmental body responsible for national public health in Canada, had a backlog of over 800 licensing applications at the beginning of 2019. That logjam seems to be breaking up which was reflected in Aurora’s fourth-quarter guidance that hinted at sequential sales growth of 59%.
Negative: Revenue is still a moving target
At first glance, it looks like Aurora had a comfortable revenue beat. The average estimate among 10 analysts is for revenue of CA$112.8 million. However, that average comes with a low of CA$88.8 million and a high of CA$132.4 million. What makes the forecast even cloudier is that Wall Street typically projects gross revenue, not net revenue. The bottom line is that, at least for the short term, revenue numbers need to be taken with a grain of salt.
Negative: Aurora is unlikely to be profitable anytime soon
Looking at the company’s fourth-quarter guidance, it’s possible that ACB could have a positive adjusted EBITDA. But that does not mean they are profitable. In fact, analysts agree that it is likely Aurora Cannabis will lose money, on an operating basis, not only for the fourth quarter of 2019 but also for all of 2020. One reason for this is the cost of developing its largest production facility, Aurora Sun. ACB has also not been shy about making acquisitions however it appears that the company overpaid for some of these additional assets. This means that investors should look at the very real possibility of write-downs which will also be a drag on profitability.
A positive earnings report may boost the stock
Aurora Cannabis reports their fourth-quarter earnings on September 24. At the moment, analysts’ opinions are split almost perfectly down the middle with 6 analysts issuing a Buy rating and 4 analysts issuing a Hold rating. The consensus price target is $11.84 (CA$15.68) which would be a gain of nearly 85% from its current price of $6.59.
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