Is Aurora Cannabis Inc. a Buy?
Aurora Cannabis (NASDAQOTH: ACBFF) generated tremendous gains in 2017. But despite a nice rebound over the last couple of weeks, the Canadian marijuana stock is still down nearly 20% year to date.
None of that matters very much, though, in how well Aurora Cannabis stock performs in the future. What does matter is how much the company can grow over the next few years and what obstacles might prevent Aurora from growing -- or keep its stock from generating gains despite the company's growth. Is Aurora a buy right now? It's a tough question.
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Great prospects
There is no doubt that Aurora Cannabis should have great prospects for growth. The Canadian recreational marijuana market opens in October. Aurora is poised to be one of the top leaders in that market.
The company definitely should have the production capacity needed to be a winner. Aurora is on track to be able to grow more than 140,000 kilograms of cannabis annually by the end of this year with its own facilities. The acquisition of MedReleaf adds another 35,000 kilograms to that total. And by the end of 2019, Aurora's expansion efforts are expected to boost its annual production capacity to more than 570,000 kilograms.
In addition, Aurora Cannabis owns a stake in The Green Organic Dutchman (NASDAQOTH: TGODF) (TGOD) and has a supply agreement in place with the smaller marijuana grower. Aurora will be able to buy 23,000 kilograms or more once TGOD's Valleyfield and Ancaster facilities are completed and operating at full capacity next year.
Aurora has already lined up recreational marijuana supply agreements with several provinces, most recently with Ontario -- Canada's most populous province. The company also invested in Alcanna, formerly Liquor Stores NA, to open retail cannabis stores when the provinces finalize their regulations.
An even bigger opportunity, though, lies in international markets. Aurora's Pedanios subsidiary gives the company a solid position in the lucrative German medical cannabis market. Pedanios could also serve as a launchpad for Aurora into other European countries that allow the legal use of medical cannabis. The company's Aurora Nordic production facility in Denmark should be a major plus for Aurora as it seeks to enter additional European markets.
Aurora bought a minority ownership position in Cann Group to get a foothold in Australia. It has exported cannabis oil to Brazil and the Cayman Islands, and has a supply agreement in place with a South African company.
There's also a huge wild card: Canada's southern neighbor. The U.S. claims the largest marijuana market in the world, but because marijuana remains illegal at the federal level, Aurora can't expand into the U.S. and retain its listing on the Toronto Stock Exchange. However, Aurora Cannabis Chief Corporate Officer Cam Battley said in June that the company is "poised and ready to enter the U.S. market in a big way very fast" if U.S. federal restrictions on marijuana are relaxed.
But great risks, too
There are four primary risks for Aurora. One is that the demand for recreational marijuana in Canada isn't nearly as large as expected. In my view, this is probably the least worrisome concern for the company. However, I wouldn't dismiss this factor altogether.
The second risk doesn't pose a clear and present danger, but I'd call it a clear and future danger. Aurora and its peers should see tremendous sales growth in the first couple of years after Canada's recreational marijuana market opens. However, a supply glut is almost certainly on the way. When you crunch the numbers of the projected capacity of Canadian marijuana producers, it will eventually outstrip even optimistic estimates of demand.
When the day comes when supply exceeds demand in Canada, a couple of things are likely to happen: Cannabis prices will fall. And marijuana growers will look to other countries to off-load their excess capacity.
That leads us to risk No. 3: the possibility that global marijuana markets don't expand quickly enough. Germany and the U.K. will likely be the biggest international markets other than the U.S. and Canada. But Arcview Market Research and BDS Analytics project that by 2022 the top five international cannabis markets (other than the U.S. and Canada) will reach $2.3 billion -- roughly half the size of the projected Canadian market. This might not be enough to prevent the supply glut from wreaking havoc on marijuana stocks, including Aurora.
The fourth big risk for Aurora Cannabis is perhaps the most significant one. Aurora's market cap is currently close to $5.9 billion. That assumes a whole lot of growth for the company. Even if the other three risks don't impact Aurora too much, there's still a possibility that the company's revenue and earnings won't grow enough to justify the stock's sky-high valuation.
Is Aurora a buy?
Aurora Cannabis' executives have publicly stated that they're not too worried about a supply glut in Canada. They think global demand will be more than enough to absorb their capacity. Of course, that's exactly what you'd expect them to say.
My view is a bit more nuanced. I think that overall global demand should exceed supply over the next decade. However, I wouldn't be surprised to see periods where supply is greater than demand. Marijuana is a commodity, and that's what happens with commodities.
It would be great if a major alcoholic beverage maker partners with Aurora along the lines of Constellation Brands' relationship with Canopy Growth. I think it could help Aurora also if the company listed on a U.S. stock exchange. For now, though, those are merely wishes.
Is Aurora Cannabis a stock to buy? My response is a cautious "yes." I do expect the stock to move higher over the next year or two. Beyond that, though, I suspect that it's up in the air. Buying marijuana stocks, even major players like Aurora Cannabis, could give investors a roller-coaster ride over the next few years.
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Keith Speights has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
