Although the Future Is Appealing, Don’t Buy ACB Stock Just Yet

Advertisement

Aurora Cannabis (NYSE:ACB) has received some harsh treatment from the markets in the last 5-6 months. From March 2019 highs of $9.96, ACB stock is currently lower by 43% at $5.7.

Although the Future Is Appealing, Don't Buy ACB Stock Just Yet
Source: Jarretera / Shutterstock.com

Of course, ACB stock has not been an exception in the industry. Other cannabis stocks like Canopy Growth (NYSE:CGC), CannTrust (NYSE:CTST) and Hexo Corp (NYSE:HEXO) have received the same treatment.

The decline in cannabis stocks is one side of the story. The other side of the story is full of optimism. The global addressable market for cannabis is expected to be over $340 billion.

Aurora Cannabis can be considered as one of the early movers in the industry and that should ideally prop-up the stock.

To put things into perspective, Aurora Cannabis has a current production capacity of 150,000kg and it will be ramped-up to 650,000kg by 2020. At the same time, the company is expanding globally with presence in 25 countries and with 15 global production facilities.

The positives do not end here; Aurora Cannabis is investing significantly in R&D to develop products that deliver high margins. This includes beverages, wellness products and nutraceuticals.

With all these industry and company-specific positives, ACB stock still is trending lower for the last six months.

Clearly, there is something the markets are worried about. And the worry is so big that it significantly overshadows the positives.

Aurora Needs to Find the Market

The global addressable market for cannabis is over $340 billion, but it does not imply that the industry is garnering $340 billion in revenue.

Aurora Cannabis has the production capacity, but it needs to find buyers of 650,000kg of cannabis annually. And Aurora is not the only player in the industry that’s boosting capacity.

To talk about the extent of potential demand-supply gap, Aurora produced 15,590kg of cannabis in 319 and sold 9,160kg.

Post expansion (100% capacity utilization), we are talking about quarterly production and sales of 162,500kg of dry cannabis. That’s a distant dream and the point I am making is that Aurora will witness significant overcapacity. Not for a few quarters, but potentially for a few years.

Further, the company reported the average selling price of dried cannabis at $5.86 for the third quarter of 2019. Even if we assume a conservative price of $5.50, selling 650,000kg of cannabis would imply a total revenue of $3.6 billion. Of course, Aurora will be selling value-added products and that should imply even higher revenue.

Consensus estimates indicate that Aurora Cannabis is likely to report annual revenue of $266 million for the year ended June 2019. Further, estimates for June 2020 are at $683 million.

Clearly, a 4.33 times surge in capacity by 2020 sounds attractive, but capacity utilization is likely to remain dismal.

Closely related to this point is my view on possible margins going forward. Be it dried cannabis or value added products, pricing pressure is likely with abundant supply. Cannabis for medicinal use or in value added products is unlikely to gain market interest automatically. It needs significant investment in sales and marketing.

Therefore, Aurora Cannabis will suffer from margin compression due to oversupply, R&D and high sales & marketing efforts. The bottom-line is that free cash flow is unlikely in the next few years. The markets are discounting this factor, among others discussed, in ACB stock price.

Final Words on ACB Stock

While I have focused on the factors that have depressed ACB stock price, I am certainly not implying that the company has no future.

However, the company has ramped-up capacity ahead of demand and I expect capacity utilization to remain low or cannabis prices to fall significantly.

In the long-term, there are opportunities in the global market for medicinal and recreational use. It would be too optimistic to assume that a potential market of $340 billion will open-up soon.

There will be regulatory hurdles and adoption of cannabis for medicinal use is likely to be gradual. My point is backed by the fact that active registered patients for Aurora medical products increased by 5% in 3Q19 as compared to 2Q19. A growth of 5% on a quarter-on-quarter basis looks good, but not for an industry that is still at an early stage of growth. The inflection point is yet to come.

In conclusion, I would advise investors to remain on the sidelines. Towards the end of 2018, Aurora Cannabis stock traded below $5 and I see those levels likely. Any price below $5 will be a good buying opportunity.

As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.

Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.


Article printed from InvestorPlace Media, https://investorplace.com/2019/09/future-appealing-dont-buy-acb-stock-just-yet/.

©2024 InvestorPlace Media, LLC