The desire of Aurora Cannabis (ACB) to build production capacity to supply the world was already troublesome to my investment thesis in the stock. The latest news that legal demand in Canada isn’t growing is a big reason for investors to become very nervous and why the stock has dipped below crucial support at $8.
Troubling Supply/Demand Equation
Only back at the start of April, Aurora Cannabis announced the decision to increase production by ~80,000 kg to a total of 625,000 kg. The move remains troubling because demand in Canada isn’t growing with the legalization of adult-use cannabis and the company is effectively blocked out of the U.S. market.
Image Source: Aurora Cannabis website
After the initial boost in sales last October, Canadians haven’t rushed to the legal weed due to a supposed shortage of legal supplies and retail locations. Or at least the market leaders suggested so, but the sales and inventory data from Health Canada continues to tell a far different story.
During Q1, finished inventory of dried cannabis surged over 60% to 30,802 kg while sales in March was basically flat with December at 7,600 kg. Even more troublesome, unfinished inventory surged to 143,773 kg. Combined inventory of 174,575 kg is enough supply for nearly 23 months or almost two years at current monthly sales levels.
Source: Health Canada stats
The cannabis oil market is in a better position with less total inventory compared to sales, but the market started with a larger finished supply and sales still peaked in December. Liters sold in March were only fractionally above the end of 2018 sales levels though total inventories have soared to 98,055 liters from an initial inventory of only 50,828 liters. At these monthly sales levels, the market has enough supply to cover sales for the next year.
Source: Health Canada stats
The lack of retail stores in Ontario until April 1 could provide another boost to sales levels for Q2. The province is home to Toronto and the largest population in Canada at 14.3 million people, but supply shortages for these stores are apparently causing some locations to cut hours. What isn’t clear is whether sales are just shifting from the online store that was open to Ontario residents prior to the opening of the retail stores.
Supply Flood
What is clear is that the supply flood is already showing up in the monthly data from Canada, yet companies like Aurora Cannabis haven’t even seen a big ramp in production through the March data. The company expects to supply enough cannabis in Q2 alone at 25,000 kg to supply the whole dry cannabis market for the quarter.
Source: Aurora Cannabis May presentation
The goal is to quickly reach 37,500 kg of cannabis production per quarter before another massive ramp in 2020 to over 150,000 kg per quarter. Even in March, Aurora Cannabis reached over 9,000 kg of dried flower equivalent or enough for the whole country of Canada in the month.
Source: Aurora Cannabis May presentation
The revenue growth in the March quarter was partly a function of adding Whistler Medical Marijuana to the business on March 1 and general increases in international locations like Germany. Another way at looking at the change is via the increase in the diluted share counts. The May diluted share count is ~1.18 billion shares versus only ~1.09 billion shares in February.
Source: Aurora Cannabis FQ3’19 MD&A
Source: Aurora Cannabis FQ2’19 MD&A
The net revenue per share only grew to C$0.55 versus C$0.54 in the December quarter for a minimal benefit to shareholders. The numbers signal how revenues in Canada weren’t actually growing as sales volumes were flat and prices were in decline.
Outside of North America, the legal cannabis demand is limited due to few countries approving the use. Management has the mindset that Canadian producers need to supply the world leading to this statement by the CFO on the latest earnings call that should make investors very nervous based on the above data points.
It took Canada five years to meet its demand for the population 33 million. So you just put that math into perspective with the EU, with Australia, Mexico and other countries that are coming online, it would take nearly 50 years to meet that demand. But we are not going to take that long because of the scale, we are now able to build upon.
The biggest wild card remains illegal supplies that are undercutting higher priced legal supplies that must pay excise taxes in Canada. Not to mention that protectionist governments around the globe are likely to restrict imports of weed or at least prefer locally grown product to support their economies.
Takeaway
The key investor takeaway is that Aurora Cannabis still hasn’t made the case of where all of this supply is going to end up when so many competitors are equally adding supply. The legal demand in Canada hasn’t shown up as expected to support any thesis of expanding supply at such a rapid clip by the end of 2020.
The next step for June is to watch the pricing as inventory starts finally reaching the market in a meaningful way. The Aurora Cannabis bulls better hope that legal cannabis sales jump or prices are likely to start crashing after a weak May sending the stock even lower.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.
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