Among the major cannabis plays, Canada’s Aurora Cannabis (NYSE:ACB) has mostly gone its own way. Rivals Canopy Growth (NYSE:CGC) and Cronos (NASDAQ:CRON) have sold billions of dollars’ worth of stock for cash to fund their growth. Aurora, instead, has used ACB stock to buy smaller companies. It has issued over 1 billion shares of Aurora Cannabis stock in the last few years.
The good news with that strategy is that Aurora may have the broadest reach of any cannabis play. Per a recent investor presentation, Aurora is active in 24 countries across five continents. This is true from a product standpoint as well: Aurora offers not just cannabis flower but softgels, edibles, and CBD (cannbidiol) products.
It’s an intriguing strategy — one with huge risk and huge reward, as I wrote earlier this year. The steady issuance of ACB stock has diluted shareholders. This means Aurora needs huge profits in order to post reasonable earnings per share (EPS). The company is expected to generate about U.S. $552 million in revenue next year; it would need over U.S. $1 billion in earnings to get its EPS over $1.
Of course, that type of growth is more likely for a diversified operator. But to achieve that growth, Aurora stock needs help in one key area. It needs marijuana legalization to move beyond Canada and a few smaller markets — and it needs that to happen relatively quickly.
The Market Risk to ACB Stock
It would seem like producers have several markets in which to sell cannabis as possession of marijuana is legalized or decriminalized in areas around the world.
But production is a different matter. Even in the Netherlands, which has been a destination for marijuana users for some time, growing marijuana is illegal. At the moment, only Canada and Uruguay offer truly legal opportunities for companies like Aurora.
The problem is that those two markets aren’t enough. There are hundreds of companies in Canada trying to get a piece of what Aurora itself has estimated at just a CAD $12 billion market. The medical market is pegged at CAD $3 billion, and the consumer market at CAD $9 billion.
Even adding in medical opportunities in countries like Germany, the problem holds. There are too many companies, too much supply, chasing too few buyers. As we have seen in U.S. markets like Oregon and Colorado, that leads to plunging prices, thin margins, and likely a lower ACB stock price.
Markets Really Matter to Aurora Cannabis Stock
For most marijuana plays, Canada alone isn’t enough. But smaller plays like Hexo (NYSEAMERICAN:HEXO) can manage better in a single market. So can a company like Charlotte’s Web (OTCMKTS:CWBHF), whose CBD focus allows it to drive sales in the U.S. and elsewhere.
In contrast, Aurora’s strategy is based on becoming a major worldwide player. That’s why it continues to build its production capacity, rivaling Canopy for the biggest in the world. That is also why it has acquired so many businesses in far-flung destinations like Uruguay, where it made a $290 million acquisition last year.
In many cases, Aurora’s initial aims are to penetrate the medical side of the market — and it appears to be building leadership in that category (their competitor, Canopy, has seen its medical sales decline of late).
But the bull case for Aurora, as it heads toward a whopping 1 million kilos of capacity, requires the demand match that production. That means recreational legalization on the producer side — not just decriminalization.
Is That a Worry for ACB?
It looks like a risk from here. Unlike Canopy, who has a deal to enter the U.S. market, Aurora has no U.S. presence yet. Its growth will rely at least in part on legalization in Europe, Latin America, and the Oceania region.
The news in those areas is mixed. Movement in Europe has been slow in part because the continent lacks ballot initiatives. The impact of that absence can be seen in the U.S., where legalization has moved by direct democracy, with politicians reluctant to embrace legalization beyond medicinal use.
Spain is a candidate for legalization, however, and Belgium may head in the same direction. Still, European movement overall seems like it will be slow.
In Latin America, Mexico may well see legalization after a recent Supreme Court decision. (Aurora has a presence in that market.) Outside of that country, however, there are reasons for caution. Brazil, led by conservative President Jair Bolsonaro, almost certainly will not pass legalization. Smaller countries have moved toward decriminalization — but not outright legalization of production, particularly in scale.
New Zealand has a referendum on the way in 2020 that could open that market. Progress in Australia has stalled out, however.
Over time, marijuana will likely gain acceptance. But for Aurora Cannabis stock, the definition of “over time” is exceedingly important.
It still trades at about 14.4x fiscal 2020 sales forecast of $552 million. Growth from there may depend on how many new markets open for the company, particularly on the recreational side. If the pace of opening disappoints, ACB likely will too. If marijuana legalization gains steam worldwide, however, there isn’t a company better-positioned. Investors should place their bets accordingly.
As of this writing, Vince Martin has no positions in any securities mentioned.