I’ve noticed there have been some commentary recently on the idea many Canadian production companies are vulnerable to low-cost recreational pot, which over time, would seriously shrink their revenue and shrink margins and earnings.
While there is some legitimacy to those possibilities for some companies, I find Aurora Cannabis (ACB) easily protected from this potential risk.
That said, Canadian cannabis producers will almost certainly come under pressure from recreational pot before low-cost competitors enter the Canadian market. Much of that will come from high percentage exposure to the adult-use market in Canada, which will eventually have more than enough supply.
Companies with little if any medical cannabis sales or meaningful international exposure, will find themselves with product they have no distribution outlet for. Aurora Cannabis won’t be one of them.
Recreational pot a side business for Aurora
It has been stated a number of times by Aurora management that its core business is medical cannabis. While recreational pot provides an immediate boost in revenue, over time the company has known for some time the Canadian recreational pot market is limited.
Even in its latest reporting period the company stated it held back some recreational pot sales in Canada in order to ensure it was able to meet its medical cannabis demand. It confirmed by those actions that its not making unwarranted assertions about its core business.
At this time recreational pot and medical cannabis generate an equal amount of revenue for the company. In the near term that may increase on the recreational side because of demand not being able to be met, and Aurora having more product than any of its competitors to meet it.
But longer term, there’s not doubt in my mind Aurora will continue to build out its medical cannabis business, and eventually become the long-term global leader.
Leading competition expected to come from Colombia
It is believed that the low cost of production in Colombia is what will eventually disrupt the recreational pot market in Canada. That is very likely, although it’s not clear how long it’ll take before that becomes a reality.
An ongoing hangover from the drug war in Colombia, lack of favorable conditions for outside investment, and weak security, at this time are overriding the positive catalysts inherent in Colombia, such as climate, popular cannabis strains, and inexpensive labor.
But even there Aurora has a presence in Colombia via its acquisition of ICC Labs in Uruguay, and it may eventually be able to partially supply the Canadian market itself with low-cost supply.
I think it’s going to take longer than people think, assuming Colombia is able to solve the many problems associated with its nascent cannabis industry.
This is another reason why Canadian producers are likely to face significant challenges from an overabundance of supply before they face low-cost cannabis imports.
But even if the worst-case scenario were to play out, Aurora Cannabis is more than prepared to mitigate the risk.
The business model of Aurora Cannabis itself is the best deterrent from low-cost production, as it not only is focused primarily on medical cannabis, but it is one of the low-cost producers in the world at this time, and it expects costs to decline to under $1 per gram in the near future.
The other thing is Aurora has been developing strong brands in its domestic market, and that means it will take more than low-cost pot to take market share from them with those strengthening brands.
Finally, Aurora Cannabis has the largest international presence by a cannabis company in the world, and global sales will incrementally become an increasingly larger percentage of the company’s business. That will command higher prices, wider margins and stronger earnings.
Even though Aurora is going to rapidly distance itself from all its competitors on the production capacity side of the business within a couple of quarter, the company still has been growing sales in important markets, and also has a lot of product to experiment with and and engage in extraction, without risking the supply it needs to meed medical and recreational pot demand.
For these reasons, I don’t see Aurora having any issue concerning stranded assets, as some companies will have as supply reaches the level of meeting recreational demand in Canada.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.
Disclosure: The author is Long Aurora Cannabis stock.