On Friday, Health Canada dealt another blow to the cannabis sector already struggling with weak demand from recreational-use sales. The so called “Cannabis 2.0” products like edibles and vapes are set for at least a 60-day delay when companies like Aurora Cannabis (ACB) are already ramping up inventory. The mix isn’t good for the stock.
Cannabis 2.0 Delay
The market originally expected Health Canada to provide approval for consumable products effectively October 17. Instead, the Canadian government organization provided final regulations on June 14 on edibles, extracts and topicals setting an October 17, 2019 effective date for the amended regulations.
The issue for Aurora Cannabis is that Health Canada is requiring the federally licensed processors to seek an amendment to their license that won’t be approved until the new regulations go into force on October 17. After that, the companies will have to provide a 60-day written notice to Health Canada before the products are available for sale.
The end result is that Health Canada expects only a limited supply of new products available in physical and online stores by mid-December. In addition, the government organization released regulations around THC limits and advertising that might trip up companies supply chains.
What really isn’t known is whether accompany like Aurora Cannabis were heading forward under the amended regulation path surrounding THC limits and packaging restrictions. The end result is that sales of edibles and topicals will slip into 2020.
Aurora Cannabis Impact
The problem for Aurora Cannabis is that the company is aggressively building supply, yet the cannabis market continues to face delays and lackluster sales. Management spent the FQ1 earnings call on May 14 discussing shifting dried flower production into inventories for the upcoming vapes and edibles market that now might take several more months to reach market while costs are mounting.
The company is already planning to ramp annual cannabis capacity output to 625,000 kg by the end of 2020 after only producing 15,000 kg in the March quarter. The June quarter supply was set to jump to 25,000 kg followed by a quick push to 37,500 kg per quarter by year end.
The issue here is that Aurora Cannabis isn’t going to have a market for this ramped up inventory with adult-use sales stalling and the market for consumables not opening up in a timely manner. The outcome is bad for a stock trading at a market valuation of ~$8 billion and analysts poised to cut sales estimates.
Analysts were forecasting FY20 revenues that end next June at $561 million but estimates for large sequential revenue gains will likely take a hit now. Estimates of quarterly sequential revenue gains of $10 to $20 million could end up hitting FY20 revenues by up to $50 million. The market isn’t going to keep paying multiples of sales for the stock of up to 15x potential revenues that are cut to $500 million or lower.
Takeaway
The key investor takeaway is that Aurora Cannabis remains too rich for the value proposition in the cannabis market that isn’t matching lofty expectations. The Canadian market will eventually see edibles and vapes reach the market in volumes, but the biggest problem is that supplies will surpass demand as the products finally reach market.
Investors will want to pay attention to prices and margins due to these delays. Don’t pay up for Aurora Cannabis until analysts cut estimates and the stock offers a better value that is in line with realistic expectations.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.
Disclosure: No position.
