At What Price Is Aurora Cannabis Worth Buying?
Right now, investors would struggle to find a faster-growing industry than legal marijuana. According to a report released earlier this year by Arcview Market Research and BDS Analytics, global cannabis sales are expected to jump 38% in 2019 to $16.9 billion, and surge past $31 billion by 2022. Investment firm Cowen Group offers an even more aggressive take on the industry, calling for $75 billion in worldwide sales by 2030. That'd potentially place marijuana ahead of annual soda sales about a decade from now.
It's this potential for rapid growth that's made Aurora Cannabis (NYSE: ACB) an instant hit with millennials. As a reminder, favorability toward cannabis tends to increase as age decreases, meaning the biggest surge in future growth (think years or decades down the road) is likely to come from millennials and possibly Generation Z.
Then again, marijuana stocks like Aurora Cannabis are far from perfect. It's a company that yours truly has often singled out as having critical deficiencies that lead me to believe it's overvalued. But this doesn't mean I don't see any value in Aurora Cannabis. It just means that the current share price doesn't properly reflect that value, in my opinion. There is, in fact, a share price where I would begin to give serious consideration to Aurora Cannabis as a potential pot stock to buy. Before revealing that price, here are the many positive and negative factors I weighed in coming up with my "buy price."
Image source: Getty Images.
The "buy" thesis for Aurora Cannabis
The most obvious reason to be enamored with Aurora Cannabis is that the company is in prime position to lead all growers in peak annual production. It's reached this pinnacle with organic builds (Aurora Sky and Aurora Sun), partnerships (Aurora Nordic), and through multiple acquisitions (CanniMed, MedReleaf, and ICC Labs). The company's own estimate of "in excess of 500,000 kilograms" of peak annual output looks to be conservative, with my own estimate, following its ICC Labs purchase, of closer to 700,000 kilos in yearly peak yield. Such robust production should lead to lucrative long-term supply deals.
To be clear, production isn't everything when we're talking about marijuana growers. There are a lot of other important nuances that come into play -- but Aurora has a lot of those boxes checked off. In particular, Aurora Cannabis is placing its focus on the medical marijuana market, even as recreational sales are set to bloom in Canada. Even with a smaller consumer pool, medical cannabis consumers are far more willing to purchase higher-priced and higher-margin alternative products, such as oils and softgel capsules, compared to adult-use weed consumers. These higher margins, coupled with economies of scale that should really kick in as the company's annual output soars, should lead to healthy margins.
The company also has a significant presence in overseas markets. Aurora ended its most recent quarter with operations in 23 countries, which is far and away more than any of its peers. This international expansion will come in especially handy by 2020 or 2021 when domestic Canadian pot production is expected to begin outpacing demand. Having overseas channels to export excess supply should help buoy Aurora's margins.
Other factors considered in the "buy" thesis include Aurora's likelihood of eventually landing a major partnership, the expected entrance of the company into the U.S. hemp market, and its ongoing acquisition of Whistler Medical Marijuana, which brings well-known weed brands into its portfolio.
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Why Aurora Cannabis isn't a buy right now
On the other hand, there are also plenty of reasons Aurora Cannabis isn't all that attractive at $7 a share (about a $7 billion market cap). The first issue, which is something I've harped on often, is the company's willingness to finance all facets of its expansion by selling its common stock and/or conducting bought-deal offerings. In less than five years, Aurora's outstanding share count has risen from 16 million shares to 998 million shares. While its acquisitions have undoubtedly created value, its dilutive activity has also hurt shareholders. Over the trailing year, Aurora's market cap is higher by 64%, while its share price is down 19%.
Another problem I have with Aurora Cannabis is that they are paying ridiculous premiums for their transactions, as evidenced by more than 3 billion Canadian dollars in goodwill on their balance sheet as of the latest quarter. Goodwill, which simply represents the premium one company pays for another once tangible assets are accounted for, is normal for an acquiring company. But having 63% of its total assets (CA$3.06 billion of CA$4.88 billion) tied up in goodwill isn't normal. Aurora can probably recoup some of this premium through developing the assets and land it acquired and via cost synergies. However, my suspicion is that we'll see some very hefty goodwill writedowns in the future, and that's something investors have yet to account for.
Tying this all together, Aurora Cannabis is also not expected to be strongly profitable on a per-share basis for some time to come. Recently, the company forecast it would begin generating positive recurring EBITDA (earnings before interest, taxes, depreciation, and amortization) during the fiscal fourth quarter (April 1-June 30, 2019), but EBITDA profits aren't necessarily indicative of bottom-line profits. International Financial Reporting Standards accounting also makes things tougher to understand for John and Jane Q. Investor than they need to be. The bottom line is that Aurora remains very expensive on the basis of forward price to earnings, and its ever-rising share count isn't helping.
Other factors I considered here include the regulatory red tape limiting supply in Canada, the persistence of the black market, as well as Aurora's current lack of a brand-name partner.
Image source: Getty Images.
Here's the price Aurora becomes attractive
So, where does Aurora Cannabis make fundamental sense for investors based on the multitude of factors listed above? While I fully understand this is arbitrary (but when isn't investing arbitrary?), I'd consider a share price of about $4 to be a reasonably attractive entry point for Aurora. That's about 40% lower than where the company is currently trading.
Why $4? Again, there's my expectation that the company will write off significant portions of the premium it paid for MedReleaf (and for other purchases) in the quarters or years to come. This is going to put a serious dent in the company's total assets and bring into question Aurora's strategy of growth at any cost.
There's also Wall Street's 2020 EPS forecast, which is calling for only $0.06 in full-year profit. At $4, this pushes the company's forward P/E down to 67, which in turn would likely lower its PEG ratio to around or below 1. Note that Wall Street doesn't currently have long-term growth forecasts for pot stocks, meaning this PEG ratio is my own approximation of the company's projected growth.
At a share price of $4, it would give investors enough wiggle room for Wall Street analysts to be wrong without completely sacking the company's stock. Plus, it's unclear whether Wall Street's estimates are inclusive of IFRS accounting or not. These one-time benefits and costs have led to massive swings in Aurora's comprehensive income or loss thus far in 2019.
In short, Aurora Cannabis is far from a lost cause. I do believe the company can succeed in its role as the country's leading producer. But, in my opinion, it's not a good value right now. If its share price were to decline to around $4, it'd be given serious consideration by yours truly as a marijuana stock to buy.
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