3 Arguments For and Against Buying Aurora Cannabis
After years of being stuck behind the curtain of prohibition, the legal cannabis industry is finally thriving. In October, Canada became the first industrialized country, and the second overall behind Uruguay, to legalize recreational pot. It was followed not long after by a handful of U.S. states legalizing or expanding access to cannabis in the November midterm elections, and President Trump signing the Farm Bill into law in December, giving the green light to hemp and hemp-based products.
Just how big could the legal weed industry be? While estimates are all over the place, investment firm Cowen Group offers the most robust sales prediction of $75 billion in worldwide sales by 2030. Meanwhile, a co-authored report from Arcview Market Research and BDS Analytics is calling for $31.3 billion in global sales by 2022, up from $12.8 billion in 2018.
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Figures like these are what has made Aurora Cannabis (NYSE: ACB) the most popular stock among millennial investors on free-trading app Robinhood. However, there's probably also no stock that's more polarizing to investors as a whole than Aurora Cannabis. You either think it's the greatest thing since sliced bread, or you find it grossly overvalued, with few if any investors taking a middle-of-the-road stance.
Three very good reasons Aurora Cannabis could make you rich
With this in mind, below you'll find three arguments in favor of buying one of the largest publicly traded pot stocks in the world. Afterwards, I'll tackle three arguments against buying Aurora Cannabis.
If there's a clear top reason to buy into the Aurora Cannabis growth story, it's the company's peak production potential. Although Aurora's management team has guided to "in excess of 500,000 kilograms" annually when running on all cylinders, it's hard to see the company near a figure this low. Rather, management had been calling for 570,000 kilos prior to the purchase of ICC Labs in South America for 264 million Canadian dollars late last year. With 92,000 square feet of existing production and 1.1 million square feet of under-construction greenhouse capacity, ICC Labs should help push Aurora close to 700,000 kilograms per year.
Even though production isn't everything, the company's sheer amount of annual output should help lead to ample long-term supply deals with domestic provinces and overseas countries where medical weed is legal. Also, the cannabis industry tends to benefit from economies of scale. This suggests that as production rises, Aurora's per-gram production costs should fall.
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Also, Aurora has perhaps the most impressive overseas footprint of any marijuana grower. Having recently reported its quarterly results, Aurora now has a presence in 23 countries on five continents. Being able to export weed to overseas markets will become incredibly important by early next decade when growers are fully operational and licensed, and domestic output handily outpaces Canadian demand. In order to avoid a serious decline in per-gram dried flower pricing, growers need foreign outlets to sell their product. Aurora has done a remarkable job of finding these outlets, which should help somewhat shield it from a decline in dried cannabis flower pricing.
The third reason Aurora Cannabis looks to be a buy is the company's focus on the medical marijuana community. Whereas a substantial majority of Canopy Growth's sales in its most recent quarter were from the recreational side of the business, Aurora still counted more medical weed sales (CA$26 million) than adult-use sales (CA$21.6 million) in its latest quarter. Though the consumer pool is smaller for medical marijuana, the product margins tend to be significantly higher. That's because medical weed patients are more willing to purchase higher-margin alternative consumption options, such as softgel capsules, oil products, and eventually cannabis-infused beverages and/or edibles. By making medical marijuana patients a priority, Aurora appears to be setting itself up for superior operating margins.
Three arguments why Aurora will send its investors to the poor house
Of course, there are two sides to every argument. Here's a look under the hood at why Aurora Cannabis may not be such a blazing-hot buy.
To begin with, it's a company that's been blessed with a couple of quarters of profitability due to one-time benefits, but that's been losing money hand over fist on an operating basis. As an active acquirer and company that's aiming to expand overseas, Aurora's expenses to construct and retrofit greenhouses, and establish overseas sales channels, are immense. Mind you, this doesn't include growing costs for sales and marketing, the addition of new employees, and the ongoing focus on branding and innovation. In other words, it could be some time before Aurora Cannabis is generating a meaningful per-share profit, and an operating profit without the aid of one-time benefits.
Image source: Getty Images.
Secondly, Aurora Cannabis remains in the shadows in the partnership department. Whereas Canopy Growth landed a $4 billion equity investment from Constellation Brands, Cronos Group snagged a $1.8 billion equity stake from Altria, and HEXO formed a joint venture with Molson Coors Brewing, the largest producer by peak output is still by itself in the corner. There were reports that Coca-Cola was interested in a partnership or possible equity stake in Aurora this past September, but a deal was never reached. Without a brand-name partner with a keen marketing prowess, Aurora could struggle to gain the same validity as its peers.
Third and finally -- and you knew this was coming -- there's the ongoing share-based dilution. Until recently, pot stocks have had minimal or no access to nondilutive forms of financing, such as lines of credit or bank loans. Instead, they've often turned to bought-deal offerings, which involve selling common stock, convertible debentures, options, and/or warrants to raise capital to undertake their expansion strategy. While these offerings are successful, they also wind up ballooning a company's outstanding share count, which weighs on existing investors and pushes down the earnings per share of profitable companies. Aurora's outstanding share count is now just a stone's throw from 1 billion when it was at 16 million less than five years ago.
The only question left to ask is: Which side of the aisle do you fall on with Aurora Cannabis?
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of Molson Coors Brewing. The Motley Fool recommends Constellation Brands and HEXO. The Motley Fool has a disclosure policy.