[Editor’s Note: This article was updated on Aug. 15 to correct the location of Lift & Co.]
Piper Jaffray analyst Michael Lavery initiated coverage of Aurora Cannabis (NYSE:ACB) stock with a “neutral” rating on Aug. 13. At the same time, the analyst gave a number of its Canadian competitors, including Cronos Group (NASDAQ:CRON), “buy” recommendations.
Lavery’s argument against Aurora Cannabis stock has to do with its rich valuation combined with the fact that the company has not invested much outside of Canada.
Here are the pros and cons of Aurora’s valuation and its geographic strategy.
Profitability May Be Elusive for Aurora Cannabis
Most of the major cannabis companies aren’t profitable. One could argue that many of them, including Aurora, might not be profitable for several more years.
One reason is that Canada’s recreational pot market may actually turn less profitable in the medium term. That’s because of expectations that the supply shortages that existed in late 2018 and into 2019 are going to turn into surpluses in the longer term as more licensed producers ramp up their production capacity.
“We’re going to have a dramatic oversupply in two to three years,” Nick Pateras, the vice president of strategy for Toronto-based Lift & Co., a website dedicated to reviewing Canadian cannabis products, stated in June at the Canadian Cannabis Summit in Calgary.
“1 million kilograms of cannabis is what the market needs right now and if every licensed producer (LP) executes on their business plan, you could have 3 million kilograms,” he added.
Of course, the gross margins for the producers of those 3 million kilograms.will go right down the toilet.
Pateras points out that Oregon has stopped issuing new cannabis licenses because the supply there is double the demand.
The same thing could happen in Canada.
InvestorPlace columnist Luke Lango, pointed out in May that the market valued Aurora Cannabis at less than $1 million per kilogram of cannabis it sold in its latest reported quarter compared to as much as $4.5 million per kilogram sold for some of its competitors.
Another InvestorPlace writer, Faisal Humayan, recently reminded readers that Aurora plans to go from a production capacity of 150,000 kilograms annually to 625,000 annually by the end of 2020, a four-fold increase.
In a perfect world, having that much capacity would be tremendously valuable.
But in any event, I would suggest that Aurora Cannabis stock is far more reasonably priced since its 33% correction that started in March,
How Much Capacity is Too Much?
In Aurora’s Q3 report, the company said that its average selling price per gram of cannabis sold in the quarter came in at C$6.40 . If Aurora was to sell every kilogram of its planned cannabis capacity in 2020 at the same ASP, it would generate C$4 billion in sales.
Based on this scenario, Aurora Cannabis’ $6.7 billion market cap doesn’t seem all that outrageous.
However, it’s highly unlikely that Aurora Cannabis is going to be able to sell even half of its capacity in 2020.
Worse still, if the oversupply issues rear their ugly head, companies are going to begin writing down the cannabis they produced that can’t be sold in some form.
The Bottom Line on ACB Stock
ACB’s Germany, Denmark, and Latin American operations enable it to produce a significant amount of cannabis and hemp in overseas countries whose populations total more than 1 billion people. As a result, Aurora Cannabis’ opportunity in Europe and Latin America is enormous.
Aurora Cannabis continues to use its industry-leading size in both Canada and abroad to capture a big part of the global cannabis market. The fact that it doesn’t have a U.S. business plan at the moment doesn’t mean it won’t enter the market in the future.
Furthermore, while it doesn’t have a huge strategic partner, if it continues to implement innovative ideas such as cultivating outside, I don’t think it will have a problem attracting a huge strategic investor.
In the meantime, I’d take advantage of any weakness in Aurora Cannabis stock caused by analysts’ comments to buy the shares at cheap prices.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.