The countdown is really winding down now. Just three weeks from today, Canada will lift the curtain on nine decades of recreational cannabis prohibition and allow adults aged 18 or 19 and older (depending on the province) to legally purchase marijuana in licensed dispensaries. This makes Canada the first industrialized country in the world to legalize recreational weed.
Although estimates rightly vary, as would be expected of an industry with little global precedence (in a legal sense), Wall Street foresees the potential for around $5 billion in added annual sales as the result of legalization. That should create some clear winners and substantial profits throughout the cannabis supply chain once the industry is fully ramped up.
But as investors, we're also acutely aware that not every company can be a winner. Though many investors are clearly seeing green at the moment, some marijuana stocks could truly go up in smoke. One such pot stock, which is potentially the most polarizing of all marijuana stocks among retail investors, is Aurora Cannabis (NYSE:ACB).
Retail investors flock to Aurora's top-tier production capacity
Aurora's claim to fame is very simple: it's on track to be the top marijuana producer of all Canadian growers -- and it's worked its way to the No. 1 spot by organically constructing greenhouses, forming strategic partnerships, and acquiring other pot businesses.
Two of the company's flagship production facilities are built from the ground up. This includes the technologically advanced Aurora Sky project, which spans 800,000 square feet and should produce around 100,000 kilograms of cannabis annually, and the more recently announced Aurora Sun project in Medicine Hat, Alberta. This 1.2-million-square-foot facility will yield an impressive 150,000 kilograms when complete and fully operational.
Earlier this year, Aurora Cannabis also partnered with Alfred Pedersen & Son in Denmark to retrofit existing vegetable-growing greenhouses to grow cannabis instead. Some 1 million square feet will yield an expected 120,000 kilograms annually for the Scandinavian market when up and running.
And then there are the acquisitions, which include CanniMed Therapeutics for $852 million, Ontario-based MedReleaf for $2.5 billion, and the more recently announced ICC Labs (NASDAQOTH:ICCLF) for just over $220 million. Prior to its ICC Labs acquisition announcement, Aurora Cannabis had guided Wall Street to expect 570,000 kilograms in annual production. My suspicion is that figure can now expand to as much as 700,000 kilograms a year once ICC's 92,000 square feet of existing grow space and more than 1.1 million square feet of capacity expansion are incorporated.
Four clear reasons this marijuana stock isn't right for you
Since it's a top-tier producer, investors are expecting Aurora to secure a steady stream of long-term supply deals as well as to be a partner of choice for brand-name beverage, pharmaceutical, and/or tobacco companies. But there are four very good reasons that, despite its leading production, Aurora Cannabis's stock isn't worth buying.
1. It lacks true differentiation
One of the reasons Aurora Cannabis quickly became one of the largest publicly traded pot stocks in the world was its ability to rapidly ramp up its capacity. But the thing is, the industry is moving beyond the capacity-expansion phase given that legalization is around the corner. Instead, investors' attention now turns to brand building and differentiation, an area in which, I'm afraid to say, Aurora Cannabis doesn't stand out.
When talking about "differentiation," I'm referring to growers that can bring something unique to the table. For example, CannTrust Holdings (NYSE:CTST) is focused on hydroponics, which uses nutrient-rich water solvents to grow cannabis plants. When combined with CannTrust's moving containerized benches, it creates what is the industry's first perpetual harvest system. In other words, CannTrust won't have lumpy harvests but rather a steady stream of production that could help lower long-term costs and allow it to more easily meet and secure long-term supply deals.
Growing more marijuana than other businesses simply isn't enough evidence that Aurora offers the differentiation needed to build a successful marijuana business.
2. Its capacity-expansion bonanza comes at the expense of investors
Although retail investors have praised Aurora's aggressive capacity expansion, what they might be overlooking is that it's also potentially coming at their expense.
Prior to the passage of the Cannabis Act on June 19, marijuana companies had an exceptionally difficult time gaining access to basic banking services, including lines of credit, loans, and even checking accounts. And since the medical marijuana industry is still budding in Canada, it hasn't been generating a lot in the way of operating cash flow for pot stocks. This meant the only way for marijuana stocks like Aurora to raise the capital needed for organic construction projects and acquisitions was through bought-deal offerings.
A bought-deal offering involves the sale of common stock, convertible debentures, stock options, and/or warrants to raise capital. Since the end of fiscal 2014, Aurora's outstanding share count from its bought-deal offerings and acquisitions has exploded from about 16 million to around 1 billion. Even as Aurora's market cap has remained in the top three among publicly traded pot stocks, its share price has fallen to reflect the impact of these newly issued shares.
3. Integration concerns
Another reason for concern is the speed at which Aurora Cannabis ramped up its capacity expansion. In just eight months, the company went from one really large puzzle piece that could yield about 100,000 kilograms a year to around a half dozen puzzle pieces capable of maybe 700,000 kilograms annually. Each of these new projects and acquisitions runs the risk of not being completed on time or of running into production delays once finished.
A few years ago, we witnessed a similar push for market share from 3D printing companies. The purported leaders in this space (ahem, 3D Systems) went on an acquisition binge in an effort to garner as much market share and 3D-printing technology as possible to best take advantage of what was expected to be an incredible growth opportunity. Unfortunately, the companies that made these dozens of smaller acquisitions struggled to integrate them. This led to higher-than-expected costs, which, when coupled with weaker-than-anticipated 3D printer demand, derailed an incredible rally in the industry.
My suspicion is that something similar could await Aurora Cannabis and marijuana stocks as a whole.
Lastly, no discussion of Aurora Cannabis is complete without noting its nosebleed valuation relative to its profit potential next year.
One of the nasty side effects of a ballooning outstanding share count is that it makes it that much harder for the company to turn a meaningful per-share profit. With around 1 billion shares outstanding following its ICC Labs acquisition, it would take a profit of 100 million Canadian dollars just to generate CA$0.10 in annual earnings per share. That would "only" give the company a forward P/E of about 120! Yikes!
But what folks have to realize is that Aurora's aggressive capacity expansion is going to have it spending far more than its peers for at least the next couple of quarters. This is going to sap any chance of substantive income in the interim. It's also why Wall Street is projecting a forward P/E of nearly 200 for Aurora Cannabis next year.
There are simply far too many questions and concerns with this pot stock, which makes it one for investors to avoid.