It has been a rough ride for shares of Canadian cannabis producer Aurora Cannabis (NYSE:ACB) in 2019. Aurora began the year priced around $5. However, it’s exiting the year at around half of that value — mostly thanks to stagnant revenue growth amid challenging demand trends in its core Canadian consumer market.
But, I think that 2020 is shaping up to be a great year for Aurora Cannabis.
The contrarian bull thesis here is simple. Those challenging demand trends in the Canadian consumer market will turn around in 2020. This is due to the launch of new products like edibles and vapes, a reduction in legal channel supply constraints and an expanded retail distribution footprint.
As those demand trends turn around, Aurora’s revenue growth will re-accelerate higher. This resurgence, coupled with favorable U.S. legislation progress, will spark a big rebound for Aurora.
As such, although it’s easy to write off Aurora Cannabis as a falling knife at this point. I ultimately think that dip buyers who exercise patience at these levels will be rewarded in a big way over the next 12 months.
The Canadian Cannabis Market Will Bounce Back
The Canadian cannabis market looks poised for a big rebound in 2020 after a rough 2019.
The big problem with the Canadian cannabis market in 2019 was that consumer demand in the legal channel fell flat. That happened for a number of reasons, all of which come back to this idea that the legal channel failed to pull that much demand from the black market.
That said, the black market had lower prices because they didn’t have to pay legal or regulatory fees. They also didn’t have any supply issues — whereas nascent legal suppliers had huge supply constraints. They were also able to get product to consumers in a timely manner — whereas legal suppliers were still learning the ropes of cannabis distribution and logistics — and offered a wider array of products that legal suppliers couldn’t sell.
Fortunately for those interested in investing in the Canadian cannabis market, all of that will change in 2020.
First, that Canadian government is aware that the black market is outpricing the legal market, and there appears to be legal steps being made to rectify this issue. Second, legal suppliers have spent all of 2019 increasing growing capacity. So, come 2020, there should be no more supply constraints. Third, legal suppliers are also aggressively expanding their retail footprint throughout Canada, and that should lead to improved logistics. Fourth, the legal market will able to sell cannabis 2.0 products like vapes and edibles in 2020.
Therefore, 2019 cannabis market demand headwinds should turn into 2020 demand tailwinds. As they do, everything will improve for cannabis companies. Revenue growth rates will ramp back up, margins will improve and net losses will shrink.
As all those things happen, pot stocks should bounce back. It also doesn’t hurt that the U.S. is inching towards federal legalization of cannabis with the House Judiciary Committee recently passing the Marijuana Opportunity, Reinvestment, and Expungement (MORE) Act.
Aurora Will Bounce Back, Too
As the cannabis sector bounces back in 2020, Aurora will bounce back, too.
I like Aurora Cannabis in the cannabis sector for a few, very simple reasons. First, the company is very big in this world. They are second to only Canopy Growth (NYSE:CGC) in terms of sales and growing capacity. After those two, it’s a steep drop off to the rest of the pack.
Second, they have a strong leadership position in the markets in which they operate. In the Canadian consumer market, Aurora owns the top three best-selling cannabis consumer products in Ontario — Pink Kush, Blue Dream and Tangerine Dream. Internationally, the company has a leadership position in medical marijuana throughout most of Europe.
Third, Aurora is supported by favorable margin trends. Gross margins here are high for the cannabis industry, up near 60% last quarter. Those gross margins are also stable, and haven’t changed in several months. At the same time, management is exercising disciplined cost control, while selling, general and administrative expenses dropped 1% quarter-over-quarter last quarter.
Fourth, the valuation on Aurora is favorable relative to other pot stocks. Aurora’s market cap presently stands at $2.7 billion. Revenue estimates for two years ahead stand around $950 million. That gives Aurora Cannabis a two-year-forward sales multiple of less than 3. Peers Canopy Growth, Tilray (NASDAQ:TLRY), and Cronos (NASDAQ:CRON) all trade north of four-times sales that are two years out.
All in all, there are a lot of positives which make Aurora stand out in the cannabis sector in a good way. Those positives ultimately mean that if the cannabis sector rebounds in 2020, Aurora could rebound by even more.
Bottom Line on Aurora Cannabis
Yes, Aurora looks like a falling knife. In 2019, it was. But, in 2020, it won’t be.
Instead, Aurora’s awful 2019 performance actually sets the stock up nicely for a big 2020 rebound amid a significant reversal in Canadian consumer market demand trends.
As such, I think patience will be rewarded here. There’s no need to rush and buy the dip just yet. Instead, be patient. Wait for signs that the turnaround is emerging. Then, buy the dip and hold for the big 2020 rally.
As of this writing, Luke Lango was long CGC.
