Aurora Cannabis Stock Is Unreasonably Undervalued

It’s been a rough run for marijuana stocks in 2019, as supply issues in the Canadian market, sluggish progress on the U.S. legislation front, and a huge vaping crisis have provided significant challenges for the entire industry. Indeed, all major marijuana stocks – including Canopy Growth (NYSE:CGC), Aurora Cannabis (NYSE:ACB), Cronos (NASDAQ:CRON), Tilray (NASDAQ:TLRY), and Aphria (NYSE:APHA) – presently trade very far below their 2019 highs.

Aurora Cannabis Stock

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In the long-term, the decline will prove to have been a buying opportunity. Over the long-term, the cannabis market still looks poised to become a $200 billion industry that will result in the creation of several $20 billion-plus companies. One of those companies will be Aurora Cannabis. Consequently, Aurora Cannabis stock looks compelling amid its recent weakness.

As of last quarter, Aurora Cannabis became the biggest player in the Canadian cannabis sector in terms of sales and volume. Its gross margins are improving, while its cash costs are dropping. Furthermore, its capacity and distribution are expanding, while the company has scored some unique and promising partnerships. As a result, analysts’ estimates for the company are increasing.

And yet, despite all that good news, Aurora Cannabis stock presently trades more than 50% off its 2019 highs, at one of the cheapest valuations in the cannabis sector, and at a huge discount to its long-term potential. Consequently, investors should buy the dip of Aurora Cannabis stock. Although its near-term outlook remains challenged, in five years, ACB stock price will be significantly higher than where it trades today.

Don’t Expect a Meaningful Near-Term Jump by Aurora Cannabis Stock

First, it is important to note that Aurora Cannabis stock likely won’t rebound tremendously anytime soon.

The cannabis market remains fundamentally challenged. Canada is still having many supply issues. The black market continues to be much bigger than the legal market in most U.S. states where cannabis is legal.

The recent vaping crisis has diluted enthusiasm for cannabis 2.0 products, including vaping offerings, set to launch in Canada in late 2019. There’s limited certainty as to when other developed countries will follow in Canada’s footsteps and legalize cannabis.

As a result, the cannabis market appears to be in a “waiting period” right now and during this waiting period, cannabis producers are running into multiple challenges. Among these difficulties are  sufficiently expanding production to meet demand, cutting production costs to match black market prices,developing brands, and overcoming potency constraints.

Aurora is going through all of those growing pains right now. As long as the company continues to go through these growing pains, many investors will have a tough time seeing the big picture. Until that changes, ACB stock will likely remain depressed.

Over the Long-Term, ACB Stock Price Will Move Way Higher

Second, it is important to note that all these growing pains will be insignificant over the longer term.

Judging an early-stage cannabis company by profitability in the top of the first inning of its multi-year growth surge is foolish. Instead, the best way to look at Aurora Cannabis is as one of the leading companies in a non-cyclical growth market that will one day spur the creation of multiple $20 billion-plus companies. Aurora will very likely be one of those $20 billion-plus companies.

The numbers are easy to follow. Cannabis consumption rates among Millennial and Generation Z consumers are converging with alcohol consumption rates. For example, last year 22% of 12th graders surveyed said they had used cannabis in the last 30 days,versus 30% who said they had used alcohol.

The black market is currently where most young consumers get their weed, even in areas where it’s legal. But that should change over time, as legalization becomes more standardized, cannabis becomes less regulated, taxes fall, the cannabis buying process is streamlined, and barriers to both buying and selling are eliminated.

Within the next decade, the legal cannabis market will be worth $200 billion, according to a Deloitte study quoted by Aurora. Conservatively, Aurora could control about 5% of that market. Assuming the Deloitte forecast quoted by ACB proves to be correct, a 5% share  would equate to $10 billion of revenue for Aurora by 2030.

ACB’s gross margins are already at 60%. Its opex rates should fall towards more normal 30% levels, eventually resulting in 30% operating margins. That’s about $3 billion in operating profits. Take out 20% for taxes. Use a price-earnings multiple of 16, which is average for the market,  Assuming those forecasts are accurate,  Aurora Cannabis stock will be worth nearly $40 billion one day.

Will it happen? All signs today indicate that it will. Aurora is one of the biggest player in the cannabis market. Its volumes and sales are growing at one of the fastest rates in the cannabis sector, and its gross margins are among the highest in the space. It has global distribution capabilities, and it has a unique partnership with the Ultimate Fighting Championship that should help it make inroads in the U.S. market.

In other words, Aurora is doing everything right. That doesn’t guarantee that it will succeed in the long-run. But it does make that $40 billion valuation in ten years look at least somewhat likely. Considering Aurora Cannabis stock has a sub-$5 billion market cap today, a “somewhat likely” path towards $40 billion in ten years is good enough to warrant buying the shares now and exercising patience.

The Bottom Line on ACB Stock

The near-term pain of the cannabis sector isn’t going away anytime soon. But in the long-run, a handful of these cannabis companies will turn into $20 billion-plus cannabis titans. At this point, it looks increasingly likely that Aurora will be one of those titans. Consequently, Aurora Cannabis stock should be bought on its recent weakness.

I’m gradually adding ACB stock on weakness, being patient, and waiting for the shares to jump over the long-run. With ACB stock, it isn’t about what happens today. Or tomorrow. It’s about what will happen over the next five to ten years. And the potential of Aurora Cannabis stock over the next five to ten years is quite huge.

As of this writing, Luke Lango was long CGC, ACB, and APHA. 

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