The cannabis industry is starting to change on the production side of the business, as a few companies, such as Aurora Cannabis (ACB), are starting to not only grow revenue, but are approaching positive EBITDA as they do so.
While I don’t think this is going to be a big catalyst for Aurora in the very near term, over the next few quarters, if it performs in alignment with guidance, it’s going to be a huge advantage over its competitors, who continue to struggle to grow revenue while reducing costs.
In this article we’ll look at why this is likely to attract a lot more interest from institutional investors going forward, and why it could surprise to the upside over the next year or so.
Revenue vs. earnings
For some time I’ve been persuaded that revenue will be the key metric to watch for cannabis producers. Those that prove they can grow sales show they have the capacity to supply growing demand. That ensures a steady flow of revenue, which when consistent, should eventually lead to lower costs on scale and becoming more efficient.
If companies aren’t growing sales, cutting costs becomes an exercise in futility because market demand for cannabis has a long way to go before being satiated. Selling a relatively small amount of pot as a profit isn’t going to attract the interest of investors for a prolonged period of time.
While I maintain my thesis that revenue is the key catalyst to watch in the near term, I am starting to believe that companies that are able to maintain sales growth and do so at a profit, are going to attract the most investor interest, and their value will increase.
Aurora Cannabis is uniquely positioned to do just that, and if it delivers on its guidance for profitable EBITDA in the current quarter, it should result in its valuation jumping significantly, along with its share price.
Its major competitor, Canopy Growth on the other hand, continues to grow revenue, but in the latest quarter, it resulted in an adjusted EBITDA loss in the fourth quarter of C$93 million, or about US$74.5 million. That’s far beyond any EBITDA losses of its competitors, which are also spending on domestic and international expansion.
When asked about that, CEO Bruce Linton said that “it does dwarf our peers and it all comes back to the war chest that we talk about which we think is going to turn into a competitive advantage over time as we’re building this global scale.”
Canopy Growth does like to wave its $4 billion plus on its balance sheet like a magic want before the market, but the reality is Aurora Cannabis has been able to land great partnerships and acquisitions without the money.
The company has also rapidly expanded at a pace internationally far beyond Canopy Growth, and is doing so while continuing to lower costs.
Profitable expansion
Aurora is on pace to boost production capacity to about 625,000 kilograms a year by early 2020. There will be some lag time there as the company goes from seed to harvest in the available facility space, but in the relatively near future the company is going to far exceed all its competitors on how much cannabis it can supply to the market.
Considering the higher margin products becoming legal in Canada, the increasing revenue coming from higher-margin medical cannabis, the low production cost per gram of $1.42 as of the last reporting period, and rising overall sales, it’s easy to see that Aurora Cannabis is close to separating itself from its competitors in a big way.
Assuming Aurora can sell the enormous amount of inventory it’ll soon have available to it, its numbers are going to shoot through the roof.
Conclusion
Aurora Cannabis has been able to do rapidly increase revenue, lower costs, and expand internationally, without having to give up control of a large part of its company, or seat board members that may or may not align with their business model and strategy.
Management has guided for positive EBITDA in this quarter. But even if it were to slightly miss and it takes another quarter to reach that outcome, the company is poised to be profitable in a very short time while it’s rapidly growing revenue.
As the cannabis market continues to grow on a global basis, it also has available holdings to increase capacity to over 800,000 kilograms annually by my estimates, and possibly beyond 1 million kilograms a year if demand warranted it.
Based upon the approximate 625,000 kilograms a year the company will be producing starting in early 2020, it has the flexibility to use its product to sell, research, extract, or apply to whatever segment it needs, without sacrificing revenue.
For these and other reasons, I still consider Aurora Cannabis to be the top cannabis company on the production side of the cannabis business.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.
Disclosure: The author is Long ACB.
