Cannabis stocks have been trading at aggressive growth multiples for quite some time, but with expectations hinging on future demand and industry consolidation, the large-scale producers like Aurora Cannabis (ACB) could reach production and revenue goals that help justify the present valuation.
Aurora stock has been able to remain stable within its current price-range of $8-$9, because the valuation hinges on the production ramp of a number of large scale grow facilities, which could take production all the way past 300K Kg/year. Hence, Aurora is in a position to trade at a multiple that seems reasonable on a forward-earnings basis assuming they can generate 20% net profit margins on $800M to $1.2B sales, which translates to a net profit range of $160M to $240M in FY’20 where investors would be paying 53x forward earnings at the low-end of earnings, which is still lofty, but seems reasonable for a rapid growth industry.
To reach those type of targets, ACB’s production ramp needs to average into a pretty high figure over the next 12-month. However, the pricing dynamics of cannabis needs to hold steady as well, for the investment into new production to work favorably for ACB.
Jeffries analyst Owen Bennett reports a number of favorable catalysts or news events that could help for some of the larger scale producer stocks:
Crowdsourced data was released by Statistics Canada for each province showing pricing data for the legal and illicit markets. Generally average prices had increased since legalisation (national average 17%) which is likely due to the supply issues we have seen (from scaling/cultivation issues, packaging bottlenecks, LPs keeping product back for extraction, lack of extraction capacity) as well as the muted rollout of retail stores from a number of provinces.
On Thursday, The House Special Committee on Criminal Justice of Missouri voted 7 – 0 to approve decriminalisation for those possessing less than 36g of cannabis. The lead sponsor of the Bill, Rep. Shamed Dogan said this bill as designed as the first step to targeting larger issues such as the opioid epidemic. We are seeing this approach echoed on a national / federal level, where sponsors are focusing on pushing through bills to tackle specific segments of cannabis legalisation (access to banking services, access for vets, etc.), which stand more chance of passing near-term than a widespread bill such as the STATES Act.
Keep in mind, Canada only legalized cannabis everywhere within its borders on October 17th, 2018. The demand for recreational creates an immediate backdrop of demand whereas the shortage of production has yet to reach the market. With pricing still 17% above pre-legalization, the trend in pricing still seems favorable, and the recent regulatory move (only 6 months ago) comes at a time where production is about to ramp considerably over the next 12-24 months. So, the regulatory scenario in Canada, and pricing trends implies that ACB should be in a position to sell at the higher-end of the selling price range, while producing much more in volume. In that scenario, ACB could report stronger margins over the next 12-months and still surprise current expectations.
It’s also worth noting that there are more states in the United States that are decriminalizing cannabis possession, such as Missouri. If more States continue to transition towards legalization/decriminalization over the foreseeable five-year period, the United States rate of consumption will likely grow adding to the growth narrative and diminishing risks tied to industry overproduction.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.
Disclosure: The author has no position in ACB stock.
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