What a difference a year has made for the cannabis industry and pot stocks, such as Alberta-based Aurora Cannabis (NYSE:ACB). Over the past year, ACB stock is down more than 46%.
As we come into November, many investors in Aurora Cannabis stock are wondering if the share price may improve to possibly close the year on a higher note. However, at this point, I don’t expect to witness much positive news to help push up the share price of most cannabis stocks, including Aurora Cannabis.
On Sept. 11, Aurora Cannabis released fourth-quarter and fiscal 2019 results that disappointed investors. Yet earlier in August, ACB stock had already decreased its revenue forecast.
So when Aurora missed the low end of its own guidance, Wall Street held the company accountable for the miss. Initially, pot stocks could do no wrong. Investors do not think so any more.
Aurora Cannabis stock’s net loss came at 2.3 million CAD ($18.3 million) on net revenue of 98.9 million CAD, with an adjusted EBITDA loss of 11.7 million CAD.
Analysts had estimated revenue of 108 million CAD. In Q4 last year, Aurora stock had reported net income of 79.9 million CAD on net revenue of 19.1 million CAD. Margins and cash flow in the quarter also disappointed investors.
Investors noted that although ACB stock’s quarterly medical sales grew slightly, Canadian medical markets seems saturated — at least for now. And it is hard to estimate when international sales will start to contribute to Aurora Cannabis stock’s bottom line. ACB’s quarterly global revenues of only 4.4 million CAD would not suffice to push the stock price up any time soon.
As a result of the quarterly results, ACB stock has recently been downgraded.
Oversupply is an Important Concern
There is a wide range of economic, cultural, and legal issues affecting the marijuana industry. One of the most important points to remember is that cannabis is an agricultural commodity. In 2018, Canada became the second country in the world, after Uruguay, to legalize recreational marijuana at the federal level.
Since then, a number of federally licensed Canadian cannabis producers have started trading on the Toronto Stock Exchange (TSE) as well as the New York Stock Exchange (NYSE).
Quarterly performances of companies like Aurora Cannabis give investors important clues as to how the demand and supply equation is evolving.
At present, Aurora Cannabis is Canada’s largest producer, which gives the company certain economies of scale. Management has set an annual target of 625,000 kilograms per year by the calendar year 2020.
Yet 2016 research by Deloitte put the estimated legal recreational market at 600,000 kg by 2021. In other words, ACB stock is fast en route to producing the total estimated recreational demand in the country.
In October, Cannabis Council of Canada, which represents 35 federally licensed cultivators, highlighted that the Canadian legal retail market has an oversupply of weed. And as the largest producer, Aurora Cannabis is also likely to have a major supply in its inventory.
Statistics Canada has just released the quarterly National Cannabis Survey. As data for Q3 from the cannabis industry shows, Canada is still a relatively small market. According to the report, “[f]rom mid-August to mid-September, nearly 5.2 million or 17% of Canadians aged 15 and older reported using cannabis in the previous three months. This was unchanged from one year earlier (before legalization).”
A more-recent report by Deloitte estimates the Canadian market for legal recreational and medical cannabis to be worth 2.6 billion CAD to 6.13 billion CAD overall.
Price of Cannabis
On the other hand, the black market is still thriving in Canada, i.e., the transition from illegal market to the legal one is rather slow. One of the most important reasons for this sluggish move to legality is price.
For Q3, the average cost of a gram of legal cannabis was 10.23 CAD, compared to 5.59 CAD for illegal weed. This big price gap between legal and illicit marijuana is quite a concern for stocks like ACB.
Another point of worry for pot producers is that there has been a sequential quarterly decline in the per-gram price of legal pot, from 10.65 CAD in Q2 to 10.23 CAD in Q3. Such a drop in price takes us back to the importance of oversupply issues in this agricultural commodity.
In June 2019, legal sales of adult-use cannabis hit 85 million CAD. Respective numbers for May and April were 79 million CAD and 67 million CAD. A basic calculation would show that the total recreational sales number for 2019 is likely to be around 1 billion CAD maximum. And not everyone is convinced that Canadian recreational pot sales will remain strong.
This decline in price marks the first drop in legal marijuana prices since legal sales began last year in October 2018.
Thus, how can a producer like Aurora Cannabis maintain high margins in an industry that does not have meaningful growth potential?
ACB stock’s disappointing earnings follow several other poor results from large Canadian cannabis companies.
A given market in an agricultural commodity eventually comes back to market equilibrium. Could it be that there are simply too many players in Canada?
ACB Stock Is Still Richly Valued
Most pot stocks are burning through loads of cash and losing money like there’s no tomorrow. Cash flows are far from predictable. Investors are concerned that the initial hype surrounding the industry could be fading further.
Since mid-March, there has been selling pressure on ACB shares. The mixed earnings results for fiscal Q4 as well as previous quarters have put further pressure on the price of Aurora Cannabis stock and other weed shares. We can easily say that many cannabis stocks are trading around 52-week low prices.
This year’s price weakness in most pot stocks including ACB has improved relative valuations, but these stocks aren’t cheap. And it is likely that the rich valuations in this commodity-based consumer market may take a further hit in the coming months.
Now investors are willing to pay less per dollar of revenue. Unless Aurora Cannabis stock improves profitability metrics, I’d be skeptical of any up move in price.
A recent study by Oludamola Durodola and Deepika Chotee from Lake Land College concludes that: “Cannabis stocks on average possess higher level of risk when compared with growth and speculative stocks on the TSX. This observation aligns well with the theory of heterogenous beliefs causing extreme volatility in the market.” In other words, “caveat emptor” or buyer beware.
So Should You Buy ACB Stock Now?
Dark clouds are circling above Canada’s marijuana industry, which is still in its infancy. As these cannabis companies mature, there might be more volatility in the sector in the coming months. Therefore, I’m not willing to place a big bet on any one company, such as ACB stock, that is currently feeling negative investor sentiment.
During November, I expect Aurora Cannabis stock to trade between $3-$4, pretty much where it is today. If you are an investor who also follows technical charts, $4 has now become a resistance level. For ACB stock to make an up move that can also act as a long-term buy signal, the share price has to go and stay above first $4 and then $5. Yet, from a valuation standpoint, the stock is not necessarily a bargain even at $4.
Canada has recently legalized cannabis derivative products like edibles. These products are expected to be slowly introduced into the market starting in mid-December. This second stage of legalization for the derivative market may give a short-lived boost to most pot stocks. Yet realizing the potential of this new segment will likely take a considerable time. The industry should remain pressured unless the leading stocks can improve financial performance, especially profits and cash flows.
The cannabis industry remains speculative at best. But there may still be an opportunity for those with a high risk tolerance. Depending on your risk-return profile, you may consider buying into ACB shares between $3-$3.5. However, expect nearer-term trading to be choppy at best. Long-term investors should be ready to hold Aurora Cannabis stock for several years.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.