The early 2019 pot stock craze has cooled over the past few months. As it has, shares of leading Canadian cannabis producer Aurora (NYSE:ACB) have cooled, too. To start the year, ACB stock rallied from $5 to $10 by late March. Ever since, the stock has drifted lower. It trades hands today below $8.
This recent weakness isn’t here to stay. ACB stock will rally back towards $10, and probably soon.
Why? Two big reasons. First, in the big picture, long-term growth fundamentals support Aurora stock up at $10 today. Second, in the near term, there are some big catalysts on the horizon that could reinvigorate pot stock hype and drive ACB stock materially higher into the end of the year.
All in all, then, ACB stock looks good here for a rally toward $10 over the next several months.
Aurora Stock Is Supported At $10
The first big reason Aurora stock can and will retake the $10 level is that long-term growth fundamentals support the stock at that level.
Aurora is the second-biggest player in the Canadian cannabis market, with nearly $50 million in revenue last quarter. The only company with a larger revenue base is Canopy Growth (NYSE:CGC). All the other players in this market largely reported revenues of under $30 million last quarter.
Aurora projects to remain a leader in this market for a long time. The company has everything you’d want in a cannabis producer, including huge growing capacity, an international footprint, a seasoned management team, strong products (they are behind four of the top five selling cannabis products in British Columbia), and big growth (300%-plus year-over-year revenue growth last quarter).
That’s largely why fiscal 2020 revenue estimates for this company sit around $560 million, well above estimates for other cannabis producers and only a hair below the Canopy 2020 revenue estimate. At that time, the legal cannabis market in Canada will likely measure around $4 to $5 billion. Thus, Aurora is staring at 10-15% market share potential in the Canadian cannabis market.
On a global basis and in the long run, that share will fall thanks to competition. But, given its early leadership in Canada, global distribution footprint and strong product portfolio, Aurora will remain a very important player. Global market share will probably settle around 5%. The global cannabis market projects as a $200 billion market. Operating margins project to hover around 35%. Doing the math on that and assuming a 20% tax rate, Aurora has an opportunity to be a $2.8 billion profit company in the long run. A market average 16 multiple on that implies a long run valuation target of nearly $45 billion.
It will take a long time for all of that to play out. Probably around 15 years. Discounting that valuation target back by 10% per year, that implies a present-day valuation target of between $10 and $11 billion, which equates to a $10-plus price tag for ACB stock.
Near-Term Catalyst Will Provide Firepower
While the fundamentals provide support for ACB stock at $10, it will be two near-term catalysts that will provide the firepower for the stock to move towards $10.
The first catalyst is the legalization of CBD edibles, extracts and topicals in Canada later this year. The introduction of these new products into the legal channel will provide a nice lift to the Canadian cannabis market and its biggest players. Supply shortages should be appeased by more breadth of supply. Demand should grow because edibles, extracts and topicals are among the most popular ways to consume cannabis. At the same time, these products are known to have better margins than dried flower. That means cannabis producers like Aurora will get a margin and sales lift in the back half of 2019.
As such, Aurora’s first-quarter and second-quarter fiscal 2020 earnings reports (due in the back half of calendar 2019) could be really good.
The second catalyst is continued progress on the U.S. legalization front. Cannabis is growing on Americans. Illinois just became the eleventh state to legalize recreational adult-use cannabis. Importantly, they did so in a unique and unprecedented way: they passed it through the legislature. This paves the path for other states to do the same, and it is quite likely that we see a flurry of U.S. states legalize cannabis over the next several months.
As that happens, investor sentiment across the whole cannabis space will improve, and ACB stock will run higher.
Bottom Line on ACB Stock
After a red-hot start to the year, Aurora stock has been stuck in a funk over the past several months as pot stock hype has cooled down amid broader economic concerns.
But, pot stock hype will likely come back into the picture in the back half of 2019 thanks to the introduction of edibles into the legal Canadian cannabis market and progress on the U.S. legislation front. As that hype returns to the sector, ACB stock will rally towards $10, since that’s where long-term fundamentals say the stock is fairly valued today.
As of this writing, Luke Lango was long ACB and CGC.