Canadian marijuana Goliath Aurora Cannabis (NYSE:ACB) filed to list its shares on the New York Stock Exchange (NYSE) earlier this month, and yesterday its shares began trading on the exchange under its new symbol, ACB. The move to the NYSE opens the door for investors who previously avoided buying because they didn't want to buy -- or were prohibited from buying! -- Aurora Cannabis shares in the over-the-counter market or on the Toronto Stock Exchange.
Here's why the company's move to the NYSE is important and what you should know about this cannabis company before investing in it.
A major market disruption
Most of the $150 billion that changes hands every year in the marijuana market occurs on the illicit black market, but increasingly, legalization is bringing these transactions out of the shadows and onto regulated marketplaces.
In the U.S., 30 states have passed laws allowing medical marijuana's use, and nine states, including California, have passed laws establishing recreational marketplaces. But despite growing momentum in the U.S., marijuana remains illegal on a federal level, and that's unlikely to change anytime soon.
The story's different in Canada. A nationwide medical marijuana market has been thriving since rule changes in 2014 cleared the way to regulating growers and retailers, and this month Canada became the first of the G7 countries to legalize marijuana's recreational use nationwide.
Although it remains to be seen how large Canada's marijuana market will be, estimates suggest that the biggest cannabis companies in Canada could be about to profit from billions of dollars in additional sales. According to Statista, medical marijuana sales in Canada were roughly 600 million Canadian dollars in 2017, and according to Deloitte, recreational marijuana sales in Canada next year could eclipse CA$4 billion.
Major investors on the sidelines
Investors interested in marijuana stocks have been hamstrung because marijuana remains a Schedule I controlled substance in the U.S. The scheduling limits access to banking services and prevents companies from conducting business across state lines. As a result, the U.S. market is highly fragmented, and most U.S. marijuana companies trade on the over-the-counter market, a thinly regulated market that has exposed investors to fraud in the past.
Instead of risking it on over-the-counter stocks, investors have been forced to look north of the border to Canada, where companies like Aurora Cannabis trade on the Toronto Stock Exchange. Buying and selling stocks outside the U.S., however, can be more expensive than trading stocks on the U.S. market, and many professional investors, including mutual funds, are governed by mandates that prevent them from owning companies that trade on foreign exchanges.
The inability for Canadian cannabis companies to tap these U.S. investors for funding wasn't a major problem in the past. However, it's become more important because the recreational market opportunity is more capital-intensive than the medical marijuana market opportunity.
In order to satisfy demand caused by a shift to a regulated market from the black market, cannabis companies are investing significantly to boost marijuana production capacity, develop distribution, and establish a brick-and-mortar and an online retail presence.
These projects have required Aurora Cannabis to issue more shares to raise money to orchestrate M&A deals. It's also reportedly prompted conversations with large, established consumer products companies, including Coca-Cola, about deals that could provide it with expertise and money. Now that Aurora Cannabis is trading on the NYSE, the company should have an even greater ability to raise money from stock offerings. It may also make it easier to negotiate with U.S. consumer products companies that may have worried in the past that a deal could jeopardize their own U.S. listing.
Is Aurora Cannabis a buy?
Aurora Cannabis doesn't appear willing to enter the U.S. market until marijuana prohibition ends federally, so its listing on the NYSE still doesn't give U.S. investors exposure to markets in individual states, such as California, that have passed pro-pot laws.
Nevertheless, there's plenty of opportunity for growth in Canada and elsewhere, including Germany. The Canadian recreational market is limited to dried flower and cannabis oils for now, but edibles, vapes, and certain concentrates could become available there as early as next year. Those products are expected to drive significant interest among new users, thus expanding the addressable market. As more products become available, beer, wine, and spirits giant Constellation Brands predicts Canada's retail marijuana market could be worth $11 billion in 15 years.
If so, then Aurora Cannabis could be perfectly positioned. Its acquisition of MedReleaf earlier this year gives it CA$33 million in trailing pro forma revenue, making it the top-selling Canadian cannabis company. The company's acquisitions also expanded it even more beyond dried flower to extracts, which command better profit margins.
Meeting Canada's demand will require increasingly more state-of-the-art production space, and Aurora Cannabis is arguably the leader there, too. It's investing CA$150 million in next-generation greenhouses, and spending on its "Sky" class facilities is expected to increase its production capacity to 570,000 kilograms, up from about 108,000 kilograms of funded capacity one year ago.
Its new production facilities are already starting to improve gross margin because automation is reducing labor costs, which are the biggest expense that's associated with operating greenhouses. Last quarter, Aurora Cannabis' gross margin improved 7% to 74%, and over time Aurora Cannabis is targeting production costs at its Sky class facilities below $1 per gram. If it hits that target, it'll be one of the lowest-cost producers in Canada.
Having said that, valuing this company isn't easy. It's still losing money on an operational basis and there's no telling when that will stop. Therefore, it's essentially useless to compare its price-to-earnings ratio to other major participants, most of whom are also losing money because of their spending on expansion projects.
Other valuation metrics, including price-to-sales ratios and price-to-book ratios, aren't much use, either. Price-to-sales ratios are based on trailing revenue that doesn't reflect the expected jump in sales next year because of legalization. Similarly, price-to-book ratios, which show how much investors are paying for each dollar of a company's breakup value, may fail to appreciate how much these companies could be worth in the future because of widespread legalization.
Personally, I think its addressable market is big enough to justify its current market cap, but it could be years before this company matures. Therefore, only aggressive investors who can withstand the fits and starts likely to occur in this industry over the next decade should consider buying Aurora Cannabis.