Leading Canadian cannabis supplier Aurora (NYSE:ACB) is set to report second-quarter earnings after the bell on Monday. Ahead of that report, I have mixed feelings. On one end, ACB stock still looks undervalued relative to its peers, and strong numbers could confirm this undervaluation and spark a rally in the stock.
On the other end, ACB stock is up more than 40% over the past month and since management gave preliminary Q2 numbers. If those numbers simply arrive in line with expectations, that could disappoint investors, and ACB stock could drop.
As such, there really isn’t sound reason to be either strongly bullish or strongly bearish on ACB stock ahead of earnings.
Instead, investors should take a step back here and look at the big picture. The numbers will be good. Will they be good enough to cause a pop in ACB stock? No one knows. But, will they be good enough to support a long term bull thesis from current levels? Yes, and that’s all that matters.
As such, this earnings report promises to inject volatility in ACB stock. But, nothing more. The best thing to do here is adhere to the long-term fundamentals, and neither buy nor sell aggressively into the report.
Expectations Into Earnings May Be Too High
My one big concern with ACB stock ahead of earnings is that buy-side expectations may be too high to satisfy even with really strong numbers.
Back in early January, Aurora delivered preliminary second-quarter numbers, which were really good. The expectations laid out in that prelim report are as follows:
- Year-over-year revenue growth of 350% and sequential revenue growth of 75%, powered by continued strong positioning in the adult consumer use cannabis market in Canada.
- Strong gross margins due to the introduction of higher-margin products like softgels.
- Flat SG&A dollars sequentially despite 75% revenue growth, implying robust margin expansion.
- Positive EBITDA within two quarters.
It is very likely that Aurora reports these strong numbers after the bell on Tuesday, and that the third-quarter guide will be equally impressive given that the company is now expanding commercial operations into the U.K.
But, the positioning on ACB stock is what concerns me. Back in early January, those strong prelim numbers caused ACB stock to rally from a $5 base. Today, the stock is more than 40% higher at levels above $7. In other words, all the good news from strong earnings seems priced in. Thus, in-line numbers could actually cause ACB stock to give back some gains.
As such, I’m cautious ahead of earnings. The numbers should be very good. But, ACB stock has already rallied in a big way since prelim numbers were released. That combination implies a fairly significant chance that investors will be disappointed following the Q2 report.
Aurora Stock Is Still Undervalued
Regardless of how ACB stock reacts to what will likely be strong Q2 numbers, investors should zoom out and look at the big picture. In that big picture, ACB stock is a materially undervalued stock supported by healthy long-term growth fundamentals.
In the potentially enormous global cannabis market, Aurora is a sales and profitability leader. With respect to sales, Aurora is right up there with Canopy (NYSE:CGC), and the company’s second-quarter projected sales of $52.5 million would be a record in this space. On the profit side, Aurora’s gross margins last quarter were 70%. That is near the top of the entire cannabis industry, too.
Meanwhile, Aurora is also a production leader. Aurora has a production capacity of roughly 150,000 kilograms of cannabis per year. That number is expected to more than triple to 500,000 by mid-2020, giving Aurora one of the largest production footprints in the cannabis industry. Also, Aurora is behind the top four best-selling cannabis products in British Columbia, and has over 30% market share in Ontario.
Overall, then, Aurora is top of its class everywhere you want it to be: sales, margins, profits, production, reach, so on and so forth. Yet, despite those favorable characteristics, ACB stock trades at a huge discount to peers. ACB stock trades at just 30 forward sales. Everyone else in this space trades at 40 forward sales multiples, and up (Canopy has a 75 forward sales multiple).
Thus, with ACB stock, the big picture says you have a leading cannabis company being valued at a fraction the price of its peers. That’s a favorable long term set up.
Bottom Line on ACB Stock
Earnings promise to inject volatility into ACB stock. While the numbers will likely be very good, they may not be good enough for investors who have bought into a 40%-plus rally over the past month. As such, caution is warranted ahead of the print.
Having said that, long-term and big-picture fundamentals imply that ACB stock is a winner from these levels. Thus, any post-earnings dips should be seen as buying opportunities.
As of this writing, Luke Lango was long CGC.
