Aurora Cannabis (ACB): The Path to Upside Goes Through Market Leadership

By Yahoofinance.com

The latest monthly cannabis report from Health Canada questions the business model of Aurora Cannabis (ACB). The Canadian cannabis leader has constantly promoted aggressive production growth to meet global demand, but the market data shows conflicting data points. When the company reports June quarter results in the next few weeks, Aurora Cannabis needs to show market leadership on rationale production goals going forward.

Inventory Flood

Health Canada stats for June reinforced the market is being flooded with supply. Sales of dried cannabis only grew 450 kg from May while total inventories surged about 50,000 kg.

The dried cannabis inventory level is now 300,000 kg and is enough supply to meet 31 months of demand. The concept that stores lack supply isn’t due to a lack of inventories lying around in warehouses. After all, the market had 97,000 kg of unfinished inventory in October that could’ve easily been converted into finished inventory by now, if the demand actually existed.

Leadership

For the market to have confidence in the sector, companies like Aurora Cannabis need to convince the market why their aggressive production growth makes any sense in light of these inventory numbers. The reason this company needs to show leadership is that Aurora Cannabis has long been recognized as the potential market leader in production with forecasts for in excess of 625,000 kg in annual production by next year on top of ICC Labs in South America.

With the release of FQ4 preliminary numbers, the company discussed reaching 30,000 kg of production available for sale in the quarter, up from forecasts closer to 25,000 kg. In essence, Aurora Cannabis alone exceeded the production for dried cannabis sales in Canada for the quarter and the excess production in the month was 50% of the sales in June alone.

Canopy Growth (CGC) has similar production beats and actually exceeded the supplies of Aurora Cannabis. Cannabis 2.0 doesn’t start until mid-December and won’t absorb all of these supplies, not to mention a ton of companies are still ramping up production.

Aurora Cannabis alone expects to reach around 155,000 kg of production each quarter, up from only 30,000 kg in the last quarter. The logic of building any more capacity is questionable, but the logic of another 5-fold increase in production doesn’t make any sense. At this rate, the Canadian leader could supply the whole demand in Canada alone.

Clearly, demand will rise over time due to further retail location expansion, but Ontario is only approving 50 new stores in October. The increased demand won’t come anywhere close to match the supply flood.

Takeaway

The key investor takeaway is that the Health Canada stats continue to support the theory of tepid cannabis demand gains matched with a flood of supply. When Aurora Cannabis reports official FQ4 results, the company needs to address the supply scenario in relation to the current bottlenecks in the Canadian cannabis market.

The stock is down around $5.50 for a fully diluted market cap near $6 billion. Aurora Cannabis still trades around 10x current fiscal year sales estimates with too many questions surrounding the pricing scenario in a market where supply appears unlimited. The valuation is more reasonable now, but the company needs to rationalize supply and show market leadership before one should turn bullish.