The green rush is in full swing in our neighbor to the north. Just under a month ago, Canada lifted the curtain on nine decades of recreational marijuana prohibition and opened its doors to the fast-paced cannabis industry. When fully up to speed, Canadian pot stocks are expected to benefit from in the neighborhood of $5 billion in added annual sales.
Now, with adult-use weed legal, all eyes have turned to marijuana stocks for tangible results. After all, prior to legalization it was really a race to see which pot stock could promise the most production or forge the greatest number of supply deals. Now we find out whether or not marijuana stocks can deliver on their lofty goals.
Aurora Cannabis dazzles with a CA$105 million first-quarter profit
Earlier this week, what's arguably the most polarizing pot stock of them all, Aurora Cannabis (NYSE:ACB), reported its first-quarter operating results. As you might have expected, strong growth was readily apparent throughout.
Total sales for the quarter hit 29.7 million Canadian dollars, up 260% from the CA$8.2 million reported in the year-ago quarter. Even sequential quarterly growth was impressive, with sales rising 55% from Q4 2018 (an approximate CA$10.5 million jump).
What really caught the attention of Wall Street and investors was the company's gross margin and bottom-line improvement from the year-ago quarter. Gross margin on cannabis sales jumped 70% in Q1 2019 from 58% in Q1 2018, which was a function of higher net selling prices for dried cannabis and lower cash costs to produce dried flower. More importantly, earnings for the quarter leaped to CA$105.5 million (not a typo), which represents a 2,862% year-on-year increase. On an adjusted per-share basis, we're talking about $0.12 in EPS.
Although Aurora Cannabis' stock declined modestly by market close following its earnings release (which can be at least partially blamed on the stock market's broad sell-off), it's pretty clear that, at least in the early morning, investors were pleased with what they saw. As a company that's capable of perhaps 700,000 kilograms in annual output, Aurora's leading position as a producer and its rapidly growing sales make it a stock that investors tend to flock to.
Three ways Aurora's Q1 report fooled investors
However, if you didn't take the time to comb through Aurora's first-quarter operating results, you were possibly fooled on a number of fronts.
1. That one-time profit comes with multiple asterisks
To begin with, even though Aurora Cannabis headlined with a CA$105 million profit, the company wouldn't have fared so well without a number of one-time benefits.
Examining its income statement filed with SEDAR (Canada's regulatory agency that's essentially its Securities and Exchange Commission), Aurora had an CA$85.8 million unrealized gain on derivatives, and a CA$144.4 million gain on the "disposal of significant influence investment" (i.e., a realized gain from its investment in The Green Organic Dutchman). These two substantive gains were responsible for pushing Aurora decisively into the black in the first quarter.
However, if you were to look at the company from a purely operating perspective, Aurora's quarter was ugly, at best. It did generate CA$29.7 million in sales, but it also reported CA$9.5 million in cost of sales, CA$35.9 million in general and administrative expenses, CA$29.4 million in sales and marketing costs, CA$15 million in acquisition costs, CA$21 million in share-based payments -- and the list goes on. Even factoring in its fair-value adjustments on biological assets, Aurora reported a CA$111.9 million loss from operations in the first quarter.
In other words, don't be confused: Marijuana stocks like Aurora are still losing a lot of money.
2. It's not producing like a leader yet
Secondly, you should understand that aside from tossing around big production figures and monumental sales growth, Aurora Cannabis isn't producing like a top-tier grower as of yet.
Sure, the company nearly quintupled the amount of cannabis it produced from the year-ago quarter, and more than doubled production on a sequential quarterly basis. But at the end of the day, it yielded just 4,996 kilograms, which extrapolates out to 20,000 kilograms a year. Even with the company suggesting in its Q1 report that it has a run rate of 70,000 kilograms per year, that's still a far cry from its projection of 570,000 kilograms at peak capacity, prior to the announcement and completion of its ICC Labs acquisition. With ICC Labs, we're probably at closer to 700,000 kilograms of annual output.
With a market cap of $6.6 billion, and as a projected top-tier producer, investors might be enamored by the company's potential. But let's be clear: It's not producing anywhere near its peak potential. It's going to take a lot of time -- and investor patience -- before Aurora really begins to ramp its production.
3. What adult market sales?
Lastly, with legalization having occurred just over four weeks ago, investors might be seeing things that simply aren't there.
For instance, yes, Aurora Cannabis did report 260% year-on-year sales growth. However, this sales growth was almost entirely tied to the medical cannabis market or ancillary businesses associated with the adult-use market.
During the first quarter, CA$24 million of the CA$29.7 million in sales was derived from the medical cannabis market. The remainder came from other segment services (CA$1.4 million), analytical testing services (CA$0.4 million), patient counseling services (CA$1.2 million), design, engineering, and construction services (CA$1.5 million), and... oh yeah... adult-use revenue ($0.6 million). That's right. Just a measly CA$553,000 in sales for the entire quarter was directed at the recreational market.
Now, to be fair, the quarter ended on Sept. 30, 2018, which didn't encompass the legalization that occurred on Oct. 17. However, it's disappointing that so few adult-use market sales were recognized to provinces and retailers in advance of legalization.
I've been hypercritical of Aurora Cannabis previously, and I stand by that criticism until proven wrong. For the time being, it's a company that's losing a lot of money on an operating basis and has a long way to go to be a true industry leader. It has also drowned its shareholders with share-based acquisitions and bought-deal offerings. For this investor, at least, it's a marijuana stock you should avoid.