Source: cnbc
Aurora Cannabis (ACB), as has most companies in the cannabis sector, has been taking a hit lately, as negative sentiment in the broader market, as well as the cannabis industry, has put downward pressure on the stocks.
Canopy Growth (NYSE:CGC) and CannTrust (NYSE:CTST) have led the internal negative sentiment in the sector, and the myth of oversupply in the Canadian market continues to have legs.
Finally, there are still many that won’t accept the superior business model of Aurora Cannabis and won’t support the company in any way because they want to see it follow the practices of its peers.
In this article, we’ll look at why these are only temporal negative catalysts and the macro level, and why the long-term prospects remain solid for patient investors.
Broader Market
On the macroeconomic level, fears surrounding the trade wars and accompanying concerns of a global economic slowdown have resulted in investors fleeing to safety. That, of course, doesn’t play into the more speculative cannabis sector, which has hurt most companies, including Aurora Cannabis.
What’s interesting about the trade wars, in particular, is that while they involved more than one country from the point of view of the U.S., the major concern is over China and what the potential fallout of a prolonged trade war would have on the global and U.S. economies.
At this time, I don’t think the market is taking into consideration that China, for the most part, is disconnected from the cannabis sector and shouldn’t have much, if any, direct impact one way or the other on sales.
Of course, it did trigger an economic slowdown; how cannabis customers chose to allocate their capital makes it probable that it would eventually take a bite of the industry.
As things stand today, the market is in a safe mode, which is why the price of gold has been climbing. That and expectations of more interest rate cuts from the Federal Reserve are also supporting gold; the resultant decline in the value of the U.S. dollar is usually a positive catalyst for gold.
These concerns and the internal pressures coming primarily from Canopy Growth and CannTrust have reduced optimism in the industry in the short term.
Canopy Growth and CannTrust
Concerning CannTrust, as most readers know, it willingly and knowingly grew cannabis in facilities not approved of by Health Canada and were caught after it was reported.
Not only that but some of the pot grown in those facilities had been sent to other markets, resulting in the recipients not being able to use the illegal supply.
Most important is that this has caused a huge black eye for the cannabis industry, and when accompanied by a flight to safety and the debacle surrounding Canopy Growth, it exacerbated the negative sentiment.
As for Canopy Growth, that was the biggest hit of all, even though it appears many investors and commentators still don’t seem to understand the implications of the firing of co-CEO Bruce Linton and the loss of face for Canopy Growth and its followers and shareholders.
The most vital thing there is Linton and Canopy Growth were considered the faces of the cannabis sector, and when Linton was relieved of his role, it had a negative impact on the sector as a whole.
As I mentioned before this happened, I believed Canopy Growth was the wrong horse to choose as the face of the cannabis industry, and when it fell from being considered at the top, the inevitable negative impact on the industry as a whole followed.
I also think this is why so many writers and pundits tend to have upped their trashing of Aurora Cannabis, as they’re mad at being proven wrong in their assessment of Canopy.
That’s not to say Canopy won’t be a good company in the future, only it’s not going to be near the top as many previously believed. My thought is Canopy is going to eventually perform at the lower end of the upper tier of cannabis companies in the world.
The point is, the market had an inflated and unrealistic view of Canopy, and when the bubble was popped, it brought confusion and uncertainty to the majority that held that outlook for the company. When combined with the above-mentioned negative catalysts, it caused many investors to flee the industry.
Aurora’s superior business model
There are those that are still unwilling to accept that Aurora’s business model is superior to Canopy’s, and most if not all others in the cannabis sector; better to learn now at this stage of the game than later when more may have been at stake.
By superior business model, I mean the intentional and skillful putting together of the pieces that will make up the overall puzzle that is Aurora Cannabis, allowing it to compete across all verticals in the industry.
The company also recognized the value of taking the leadership in production capacity and took aggressive steps to ensure it would be the global market leader in that regard. That scale, over time, will allow it to do things few if any of its competitors will be able to do, such as allocate product to various segments of the market as needed.
Another superior part of its business model is its refusal to give up control of the company in order to placate traditionalists that were looking for that to happen. It has also been very circumspect in entering into partnerships. Again, this has been considered a negative by some in the market, but I view it as a measured response to being sure it fits in with the overall vision and strategy of the company. After all, ask Bruce Linton and others at Canopy Growth how the cash infusion from Constellation Brands (NYSE:STZ) is working out for them. Even after the $4 billion invested, it hasn’t been able to continue to grow revenue from recreational pot, even when it said that was its main business. On the other hand, Aurora has not only been able to increase recreational sales but also sell almost the same amount in the medical cannabis segment.
Aurora Cannabis has been on record for some time saying its primary business is medical cannabis.
That will play well soon in the Canadian market as it has the product on hand to serve up a variety of derivative cannabis products once it is given approval in October. Sales will start in the last half of December.
Probably, the most glaring piece that Aurora is missing is a foothold in the U.S. market in a significant way. The company has been clear it’s going to address that issue but added it’s not going to rush in like some other companies have, without being convinced of the potential of specific categories, such as infused drinks.
Its partnership with the UFC was a huge announcement with long-term growth potential, but the market apparently only wants to reward the company for deals that are immediately accretive to its top and bottom lines. It’s refusal to do deals for the sake of doing them impresses me about the company, and the discipline of holding off until it makes sense is a good one. There is still a lot of things the company can do, and I believe there is a lot of time to enter into good partnerships in the U.S. market.
What most people don’t get about Aurora is just because it was aggressive in securing production capacity by making some quick deals that were dilutive to the stock, doesn’t mean it is reckless and without discipline. Most of what Aurora wanted to do on that side of the business is now in place, and as it scales out and lowers costs and widens margins, it’s going to be very profitable over the long term.
The myth of Canadian oversupply
There’s one idea that has been increasingly circulating in the financial media and that is that the Canadian cannabis market is vastly oversupplied. That’s a myth that needs to be laid to rest once and for all.
While that time will eventually come, it’s nowhere close to being a reality at this time, and for Aurora, its market-leading global presence provides a lot of demand for its rapidly growing production capacity, which will reach over 625,000 kilograms annually by the second quarter of calendar 2020.
The most important thing here to take into account is how to define oversupply. The reason for mentioning that is the rollout of retail outlets in Canada has been so slow, that it could be interpreted as oversupply if you mean supply, as measured against the low number of existing stores and dispensaries, exceeds demand.
But the reality is demand is very high, and while it appears cannabis is sitting on the sidelines, the fact is it has nowhere to go because of the lack of outlets not because there is too much cannabis floating around the Canadian market.
For example, the province of Ontario has between 14 million and 15 million people at this time, and less than 25 retail outlets serving it. That accounts for between 38 and 39 percent of the Canadian population. The city of Toronto only has 5 retail stores people can get cannabis from.
That is rapidly going to change after a recent lottery that will add another 13 stores in the city of Toronto and a total of 42 in the province (including the Toronto stores).
As the charts from Health Canada below show, at a cursory glance, it would appear the Canadian market is being flooded with cannabis far beyond demand.
Source: Health Canada
Source: Health Canada
That would be a legitimate concern if the retail outlets were in place and already meeting demand. But since that’s not even near to being the case, the idea of oversupply as measured by the data included in the charts doesn’t offer much value to investors, other than showing what the overall size of inventories are, and how much cannabis is being sold in May 2019 in Canada (the latest available figures).
Also of value is to take into account that all inventory isn’t necessarily for the purpose of being resold. Some will be for research and development, as well as for, in the case of Aurora, being exported to global markets.
Concerning oversupply, it’s far too soon to declare the Canadian market is flooded because the retail infrastructure is still being developed. As shown in Ontario, it’s not even close to halfway finished.
Last, with the opening up of the Canadian market to derivatives, that’s going to generate a lot more sales in the country. That and the increase in retail outlets and dispensaries will eat up a significant amount of supply.
Conclusion
Aurora Cannabis continues on its robust growth trajectory, and it really hasn’t come close to its potential in Canada, and even less so in the global markets.
That’s not because of any lack on its part, but because the infrastructure and slow pace many countries are taking to ensure longevity and consistency in the space is taking time. As that works itself out, Aurora Cannabis remains to top international player in the market, even as it continues to increase recreational and medical pot revenue in Canada.
With derivative sales in Canada, ongoing growth in international markets, and some partnerships expected to be entered into going forward, the company remains on solid footing and should be able to turn a profit in the not-too-distant future.
Since Aurora is about to separate itself in a big way from its nearest competitors in relation to production capacity, it’s important to take into account the fact there are no oversupply problems as it relates to demand in Canada. Oversupply is disproportionately related to Aurora because it suggests it will be sitting on a lot of cannabis if it has nowhere to sell it. That’s not the case as I’ve proven above.
The narrative for the company remains in place, and its recent slide is more related to factors outside of its control than any internal operational and execution problems.
For these reasons, investors should take a patient view of Aurora as it continues to implement its growth strategy as it moves closer to profitability. I look at corrections as buying opportunities, not as a reason to dump the stock because of fears it will somehow fail shareholders.
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.
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