Ready or not, here comes the green rush! Following the end of nine decades of recreational marijuana prohibition in 2018, Canada became the first industrialized country in the world, and only the second overall, aside from Uruguay, to legalize adult-use weed this past October. When combined with two-thirds of all U.S. states having now legalized medical cannabis, the market for North American cannabis is budding.
After generating an estimated $12.2 billion in global sales in 2018, Arcview Market Research is calling for a surge in sales to $31.3 billion worldwide by 2022. Even more aggressive industry sales estimates come from Cowen Group and Jefferies, which foresee sales hitting $75 billion by 2030, and perhaps as high as $130 billion (although no timeline was given), respectively.
Investors flock to marijuana's "Big Three"
It's this rapid change in sentiment and underlying law, along with monstrous sales projections, that have investors piling into Canada's "Big Three" pot stocks -- Aurora Cannabis (NYSE:ACB), Canopy Growth (NYSE:CGC), and Aphria (NYSE:APHA). You'll note that by "Big Three" I'm not referring to their market caps, although Canopy Growth and Aurora Cannabis just happen to be the respective Nos. 1 and 2 in size. Rather, I'm talking about Canada's projected top marijuana producers.
Aurora Cannabis, which had been forecasting 570,000 kilograms of peak output prior to its ICC Labs acquisition in South America, should have a realistic shot at 700,000 kilos in peak annual output by 2021 or 2022.
Meanwhile, Canopy Growth has been far more tight-lipped about its potential production. What we know is that the company has more than 4.3 million square feet of licensed growing capacity spanning 10 sites, but that it's aiming for 5.6 million square feet, in aggregate. Assuming an industry average yield of about 100 grams per square foot, Canopy Growth has a realistic shot at 500,000 kilos to 550,000 kilos in annual yield.
And then there's Aphria, which, according to management, should hit 255,000 kilograms of peak production. Most of this will come from the company's organic Aphria One buildout (100,000 kilos) and its joint venture project with Black Diamond Farms that'll see vegetable-producing greenhouses retrofit for cannabis production (120,000 kilos).
Together, these major growers could account or between 1.4 million and 1.5 million kilos of peak production a year, which is more than the entire country of Canada will likely demand by 2021. Unfortunately, these companies together are also generating massive operating losses.
Canada biggest pot producers have lost a staggering amount of money in fiscal 2019
To be fair, reading a Canadian cannabis grower's income statement should require a degree in accounting, because the statements are often filled with a number of one-time benefits, costs, and fair-value adjustments.
For instance, Canadian pot companies adhere to International Financial Reporting Standards (IFRS) accounting. In simple terms, that just means marijuana is treated as an agricultural product and, as such, these growers are required to revalue their crops throughout different stages of the growing cycle, as well as estimate the cost to sell their product, often well before they actually sell their harvest. IFRS accounting leads to a lot of guesswork, and in the early going it's also led to some pretty hefty upward lifts in pot stock bottom lines.
However, if we were to remove these smoke-and-mirror accounting tactics and focus solely on net revenue (less excise taxes) and operating expenses, the bottom line is that marijuana's "Big Three" are losing a lot of money on an operating basis in fiscal 2019.
Aurora Cannabis, which is six months into its 2019 fiscal year, reported an operating loss of $192.1 million Canadian in mid-February. Canopy Growth, the largest pot stock by market cap, has lost CA$402.6 million on an operating basis through the first nine months of fiscal 2019. Lastly, Aphria has racked up CA$31.9 million in operating losses through the first six months of fiscal 2019. Added up, that's CA$626.5 million in operating losses so far in 2019, or $471 million U.S. dollars. At this pace, even with rapid sales growth, it's possible that Canada's biggest pot stocks may lose in excess of $700 million on an operating basis, combined, in fiscal 2019.
Be prepared, because "show me" time is coming
Investors might be inclined to point to the most famous case of operating losses that were somewhat meaningless in the early going: Amazon.com. However, Amazon was building itself into a powerhouse in niches that simply didn't exist before. The cannabis industry has existed (at least illegally) for a long time, making the comparison that of an apple and an orange. Instead, investors should understand that Wall Street's patience with big losses will eventually grow thin, and that a "show me" state of mind is bound to take over sooner rather than later.
Aurora Cannabis, while purportedly on track for recurring positive EBITDA (earnings before interest, taxes, depreciation, and amortization) by the fourth quarter of its current fiscal year (April 1-June 30), is far from a shoo-in to generate a meaningful profit anytime soon. The company's growth-at-any cost strategy has seen it acquire one company after another and dilute investors in the process. With around 1 billion shares outstanding, Aurora would have to make a lot of money just to pass spec with fundamentally focused investors.
The wait for Canopy Growth to turn a profit is probably going to be even longer. Canopy's push into international markets, its strategy of acquiring complementary businesses, and its spending on new products and marketing, could keep the company running in the red on an operating basis until 2021. Even with Constellation Brands thought of as a possible acquirer of Canopy Growth, maintaining a $16 billion valuation with persistent losses could prove impossible.
Then there's Aphria, which is still attempting to overcome a loss of shareholder trust from early December. With no major partner as of yet, and a similar share-based dilution problem as with Aurora and Canopy, meaningful per-share profits could be a ways off.
Long story short, you should probably temper your expectations for the industry.