Excise tax and lower net pricing hurt quarterly results for Aurora Cannabis (NASDAQ:ACB) and although it knocked Aurora stock lower, shareholders are mostly un-phased. A ramp-up in output increase the firm’s market share in Canada, which already stands at 20%, and lower cash costs will offset the near-term headwinds.

Aurora Cannabis reported revenue of $29.7 million, up 55% from last year’s $19.1 million. Costs of sales fell slightly by 2% while average selling prices were mixed. The average selling price of dried cannabis rose 5% while that of cannabis oil fell 10%. Even though demand outstrips supply, the firm still increased its production to 4.996 million kilograms, up 126%.

Supply, Demand and Aurora Stock

The inability to output enough supply to meet strong demand hurt Aurora’s revenue growth levels in the quarter. CEO Terry Booth said that if he were to lose sleep, it is due to the company’s ability to supply the global cannabis market.

Although excise taxes hurt net pricing, the global market for cannabis is very healthy.

Aurora expects prices will hold at least the $11 a gram average price. And as it offers a premium through its strong branding, prices will go up.

Astute investors will ask if cannabis is in short supply globally. Overall supply is not limited, only legalized cannabis is. This is an important distinction because the bottleneck from legalization is constraining supply. So long as this imbalance exists, cannabis firms will not reach their peak revenue potential in the near-term. This is net positive for Aurora stock.

The company is resolving supply constraints through assistance from its extraction partner, Radient Technologies. The Radient facility is in Edmonton and has the capability of processing 200 kilograms a day of cannabis into oil. Once the facility expands, it will process 1,000 kilograms a day. This is on top of 10,000 kilograms a day of industrial hemp.

Risks and Aurora Stock

If legalization is too slow, Aurora and other cannabis firms could face competition from the underground market. Fortunately, Aurora Cannabis is targeting the medical market primarily. And if positive clinical study results drive the stock’s future valuation, the market will willingly assign a higher value for the stock.

Canada’s excise tax of 10% cost the company $3 million and had a negative impact on the net selling price. In the second quarter, dried cannabis and cannabis extract pricing was $6.23 and $10 a gram, respectively. This is due to lower wholesale pricing in the Canadian market but also the tax. The company is opposed to the tax and is absorbing the cost instead of passing it to its medical patients.

Outlook

Aurora reiterated its positive EBITDA target for the fiscal fourth quarter, which ends in June 2019. From there, it expects the business will be operationally cash flow positive. In the near-term, it will get there by driving down costs through economies of scale. It is protecting its profit margin by maintaining its global leadership and market share in Canada.

For the medium term, Aurora Cannabis will leverage its R&D activity. Vapes, CBD and infusions are higher margin products that will help the company sustain its profit margin levels. In the long term, branding will play an essential part in the company’s profit margin sustainability.

Valuation and Your Takeaway

According to Tipranks, a site that aggregates Wall Street calls, the three analysts covering ACB stock have a 39% upside target on the stock. Conservative investors should notice that at a $7 stock price, the market capitalization is already at $7 billion.

At an annualized rate of $200 million in revenue, the stock trades at 35 times sales. Aurora investors are buying an expensive stock, which may pay off if it delivers on long-term revenue growth.

Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.