- My view on Aurora Cannabis.
As my article on Canopy Growth spurred so much interest, even though the bulls might not have liked it, I’m happy to hear that nothing I said was wrong and that I only omitted the international growth story from my analysis.
My take is that in the long term, you can have as much growth as you want but shareholders might not see much benefit as the business model isn’t rewarding to them. Given the interest, I decided to dig into some other marijuana stocks to see whether I’ll find something better. Let’s start with Aurora Cannabis (TSX: ABC).
The first thing I noticed when going through ABC’s investor relations page is the constant news flow where everyday something happens.
There’s a new facility in Alberta, new patents, first ever exports, the biggest acquisition in cannabis history with CanniMed, etc. Let’s first look at this acquisition and at the new facility. There’s a lot about business and the stock market to be learned here.
The CanniMed Acquisition
So, on September 30, the company had 368 million shares outstanding and then issued 69.3 million common shares and paid approximately C$134 million for the CanniMed shares taken up. Thus the number of shares outstanding has been increased by 19%, let’s say it will be 19% when all shares are acquired as the first tender took 93.6% of CanniMed stocks. CanniMed will delist form the Toronto Stock Exchange but as it is still listed, we can see its financials and what ABC bought.
The book value of CMED is C$98 million, but Aurora paid about $702 million for the company which means that the value of the brand is $600 million. Let’s dig deeper.
CanniMed had $17 million in sales in 2017, thus ABC at current market valuations paid a price to sales ratio of 41.
Another interesting fact is that ABC became a public company through a reverse take-over of Prescient Mining Company. A reverse takeover is usually done when you don’t have enough credibility or business sense to go to the market yourself and then you take over a zombie company.
Nevertheless, the business of ABC lies on the promise of developing Aurora Sky, a facility that is expected to produce 100,000kg of cannabis per year. Another project is Aurora Sun which should also produce more than 100,000kg per year. With Aurora Nordic in Denmark, ABC hopes to produce 430,000kg per year.
Another interesting thing is that Aurora made a deal with Canaccord for C$200 Million Bought Deal Financing where the company issued C$200 million of convertible debentures. I don’t think Canaccord is going to convert, so Aurora will have to refinance C$200 million in two years which means that the business has to be up and running, and profitable, by then.
What’s funny is that Canaccord has lots of shares already but at much lower prices of $3 back in November when the previous deal was closed.
So, huge dilution coming in all kinds and forms. I wonder, if this cannabis is such a great deal, why don’t they just issue normal long term bonds and have absolutely no dilution. Perhaps I don’t know enough about how a business is run…
For now, Aurora has produced 1,000kg of cannabis in the last quarter and generated revenue of C$8.2 million. The cost of doing that was around C$4 million where the gross profit would be C$4 million.
The gross profit on the 450,000kg produced would be C$1.8 billion. If we estimate sales costs to be much less in percentage than they are now due to scalability, we could see ABC with an operating profit of C$1 billion which would be C$3 per share. When they pay taxes and other costs, we could be at C$2 per share in profits.
At a PE ratio of 10, when the company is mature and the competition fierce, the stock price per share should be around $20 if there is no dilution in the meantime. If the company continues with its dilution practices of 100% per year, the EPS would drop to C$1 and the stock price would be around C$10, which isn’t much higher than where it is now in the best case scenario. Back of a napkin calculation, but sometimes this is enough to see what can happen with a business.
If I were more conservative, I would see that sales and marketing are 44% of revenue so it’s costly to sell their product which means that if sold wholesale, the selling price would be much lower and closer to the production cost. If they manage to have a healthy margin of C$1 per gram, or C$1 million per kilogram, profits would be around C$450 million. Subtract costs and taxes, you get C$ 200 million which is low as a future possibility on a company that has to grow revenue 150 times to get where it wants to be.
These cannabis stocks are extreme long shots at these valuations. Be sure to balance your portfolio properly, understand the risks, and take advantage of the trend, if there will be a trend. The current one isn’t that positive.
For me, this is all too much hope and promise for a company with a market cap of C$5 billion that was almost double that in January.