Canadian cannabis giant Aurora (NYSE:ACB) is set to report third-quarter earnings after the bell on Tuesday. Investors shouldn’t get too excited about the report. Long story short, pot sales appear to have stagnated in Canada in the early part of 2019, mostly due to demand confusion and supply shortages, and affecting marijuana stocks. Thus, Aurora’s numbers likely won’t be all that great, and ACB stock could drop in response.
But the third-quarter earnings report and subsequent stock price reaction are just noise for Aurora. Zooming out, the long-term growth fundamentals supporting ACB stock are healthy, and the valuation underlying the stock is very attractive relative to its marijuana stock peers. Further, it does seem like only a matter of time before Aurora scores a big-time consumer staples investment. Once it does, this stock’s relative valuation discount to peers will cease to exist, and Aurora stock will soar.
In other words, when it comes to ACB stock, it’s all about the big picture, and a quarterly earnings report just a few months into Canadian cannabis market legalization isn’t a big deal in that big picture. All Aurora needs to do this quarter is report triple-digit sales and volume growth — preferably with both above 300% — and the company will have affirmed that it is the number two player in this market, only narrowly behind Canopy Growth (NYSE:CGC) in terms of sales and volume.
But Canopy is a $15 billion company. Aurora is an $8.5 billion company. Thus, if Aurora does affirm that it is right behind Canopy this quarter, then the long term bull thesis supporting ACB stock will remain in-tact.
The Quarter Will Be Mixed for ACB Stock
Aurora’s third quarter numbers likely won’t be that great. But, they won’t be awful either. Instead, they will likely be a mixed bag with big but slowing growth rates.
Context is important here. It increasingly appears that the Canadian cannabis market got off to a sluggish start in the new year. Aurora’s peer, the high-flying Cronos (NASDAQ:CRON), recently reported weaker than expected first quarter sales and volume numbers. Revenues rose just 15% quarter-over-quarter, while volumes rose just 7% sequentially. These relatively muted quarter-over-quarter growth rates corroborate government numbers, which show an unimpressive cannabis sales ramp in early 2019 wherein cannabis sales in early 2019 are essentially flat with sales in late 2018.
Against that backdrop, it looks likely that Aurora will similarly report weaker than expected third quarter sales and volume numbers which comprise muted sequential growth. Investors won’t like that. This early in the game, growth should be ramping sequentially. If it’s not, investors will be disappointed, and selling will ensue.
To be sure, the numbers will still look great on a year-over-year basis. I fully expect revenues and volumes to still rise 300%-plus year-over-year, which is very impressive. As such, growth will remain big. Just not big enough.
Net net, Aurora’s third-quarter numbers will likely be a mixed bag that comprises big but slowing growth. Investors won’t be too impressed with the slowing growth part, and ACB stock could fall in response.
Aurora Stock Looks Good for the Long Term
In the big picture, mixed third-quarter 2019 numbers from Aurora aren’t all that important. Instead, what is important is that Aurora is the second-biggest player in the Canadian cannabis market, with a stock that’s trading at a dirt cheap valuation relative to peers. This valuation discount won’t last forever. When it closes, ACB stock will fly higher.
First, it is important to understand that the cannabis market will be huge. Young consumers like to smoke weed more than they like to drink, and this will ultimately manifest itself into huge demand for cannabis around the world. Eventually, all this demand will filter through the legal channel once consumer confusion clears up and supply shortages are fixed. Broadly, then, the legal recreational cannabis market could one day be as large as the alcoholic beverage and tobacco markets. Those are $500-billion-plus markets.
Right now, the testing grounds for this global $500-billion-plus potential market is in Canada, since that’s where cannabis is fully legal today. In that testing ground, Aurora is the second-largest player, with a revenue and volume base that dwarfs Cronos and Tilray (NASDAQ:TLRY), and is only slightly behind Canopy. Yet, despite being the second-largest player in Canada, Aurora has a market cap that is only slightly larger than Cronos and Tilray, and well smaller than Canopy. Indeed, the market is valuing each kilogram of cannabis sold by Aurora last quarter at just $1.2 million, versus $1.5 million at Canopy, $2.3 million at Tilray, and $4.6 million at Cronos.
Why the relative valuation discrepancy? The company doesn’t have a major investment from a consumer staples giant. Canopy has a roughly $4 billion investment from Constellation Brands (NYSE:STZ). Cronos has a roughly $2 billion investment from Altria (NYSE:MO). But this is only a temporary problem. As the second-largest cannabis company in Canada trading at a huge discount to peers and growing just as quickly, Aurora is in a great position to receive big-money interest soon.
Once the company does get a big-money offer, then Aurora stock will fly higher.
Bottom Line on ACB Stock
Aurora’s third-quarter numbers likely won’t be great, and ACB stock could fall in response.
But, zooming out, the big-picture fundamentals supporting Aurora remain intact. Namely, the cannabis market still projects to be huge one day, Aurora is currently the number two player in that market, and a big money investment will likely arrive sometime later this year. So long as those three things remain true, then the relative valuation discount in ACB shouldn’t exist, and buyers here should be rewarded in the long run.
As of this writing, Luke Lango was long ACB and CGC.
