Aurora Cannabis (NYSE:ACB) shareholders just can’t catch a break. Just when it looked like ACB stock might stop its post-earnings tumble, the company found itself on the wrong side of analysts’ action.
Yesterday MKM Partners warned investors it doesn’t believe Aurora’s EBITDA will turn positive until early 2021, versus the market’s previous assumption that the company would hit the milestone sometime in the latter half of 2020.
Either estimate may only be wishful thinking, though, given the dynamic most investors can’t readily see. Specifically, without a big cash injection and/or a bigger, deep-pocketed partner, Aurora Cannabis stock may continue to dwindle.
In retrospect, all of the company’s aggressive investing in production capacity may have turned out to be a big — and expensive — mistake.
What MKM Said About ACB Stock
“We believe the next reported quarter will not show meaningful net sales acceleration,” wrote MKM Partners analyst Bill Kirk, adding “Increased costs, without the hoped for sequential revenue growth, results in profitability that is likely to disappoint.”
Kirk specifically referenced Aurora Cannabis’ recent warning that purchases of its produced pot were slow in July and August. He wasn’t limiting his concern to Aurora stock, though. That supply headwind should also, he suspects, work against Canopy Growth (NYSE:CGC), Tilray (NASDAQ:TLRY) and Cronos Group (NASDAQ:CRON).
The shortage raises questions though, particularly in light of one key nuance few investors (and even analysts) have acknowledged.
Specifically, growers are producing more than enough cannabis to meet demand. They’re simply struggling to get that product to dispensaries and outfits that can convert marijuana plants into CBD oil and the like. Once the logistical hurdles are cleared and retailers can access all the cannabis they want, the overwhelming supply could send marijuana prices plunging.
That could be negative for Aurora Cannabis stock, as the company has spent more than a couple of billion dollars in an effort to secure enough capacity to produce more than 500,000 kilograms of cannabis per year.
That spending may have been based on assumptions that cannabis prices in Canada would remain around $6.00 per gram. But there’s no way that can happen.
Crunching the Numbers
For perspective, Cannabis Benchmarks reported late last month that of June’s 62,671 kilograms of marijuana produced by growers, only 11,178 kilograms was actually consumed. That gap grew for a fourth straight month, and Cannabis Benchmarks estimates that current inventories can satisfy more than three years’ worth of demand.
That estimate has to be taken with a grain of salt. More dispensaries may well ignite more demand. The introduction of edibles later this year and next could also spur new demand for cannabis products.
Yet, given that Aurora alone could easily meet Canada’s current annual demand for cannabis, one has to wonder how long it will be until producers initiate a full-blown price war.
Entering the edibles market and the U.S. market after Congress legalizes cannabis would be catalysts for ACB stock. But it’s hard to gauge the power of both catalysts.
Perhaps more importantly, though, big agricultural names like Archer Daniels Midland (NYSE:ADM) and Bunge (NYSE:BG) would likely be drawn into the cannabis growing business if the U.S. market totally opens up. In the end, cannabis is just a commodity, and size is everything in commodity businesses.
Looking Ahead for Aurora Cannabis Stock
Of course, the cannabis market is in flux. More dispensaries are being established. Edibles will make cannabis use more appealing. Meanwhile, Canada’s licensed producers haven’t tapped all of their production potential, and most of them are shipping to quickly-growing overseas cannabis markets. As a result, pricing pressures may not be disastrous.
On the flip side, it would be naive for the current and prospective owners of ACB stock to ignore the risks ahead. If the Canada market becomes more liquid, supply will increase, working against pot prices. But if Aurora does not greatly increase its production, all that acreage Aurora has purchased will have been for nothing.
There’s also a distinct possibility that total demand for cannabis just isn’t going to live up to the hype whipped up a little over a year ago. Stifel analyst W. Andrew Carter warned last month that demand for edibles may be “more muted” than anticipated. That possibility was enough to prod Carter to downgrade ACB stock to a “sell.”
All of the topics described above are key reasons why Aurora stock is down more than 60% from its March high and still frequently making new 52-week lows. MKM’s Kirk may be on to something, and his pessimism may even have been overly optimistic.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.
