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Better Marijuana Stock to Buy: HEXO or Aurora Cannabis

By Todd Campbell – Apr 7, 2019 at 10:16AM

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Is one of these two cannabis companies the best marijuana stock to buy now?

Canada's top marijuana producers are seeing sales soar following the country's national recreational marijuana market opening last October. Canadians illegally spend more than 5 billion Canadian dollars every year on marijuana, so the potential to profit as billions shift from the black market to licensed dispensaries is significant. The opportunity isn't limited to Canada, either. The global marijuana market is worth $150 billion per year, according to the United Nations. Momentum to legalize marijuana is increasing worldwide, so buying marijuana stocks could be wise.

But that doesn't mean every marijuana stock should be added to portfolios right now. For instance, HEXO (HEXO -0.75%) and Aurora Cannabis (ACB 0.76%) are both fast-growing cannabis companies, but one may be a smarter buy than the other.

Capitalizing on adult-use sales in Canada

Aurora Cannabis is by far the larger company of these two. Its annualized marijuana growing capacity is estimated at about 150,000 kilos currently, and as a result, it was Canada's second-largest recreational marijuana company by revenue in the fourth quarter. Aurora Cannabis' net revenue was CA$54 million in the fourth quarter, up 363% year over year, including CA$47.6 million in net sales from cannabis. The company's net sales to the recreational use market in Q4 totaled CA$21.6 million.

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In its most recently reported quarter ending Jan. 31, HEXO's net revenue was CA$13.4 million, up 1,017% year over year.

Aurora's clearly a much bigger company than HEXO by sales, but investors should remember that a lot of Aurora's growth is because of an aggressive acquisition strategy. HEXO's growth has relied less on acquisitions, but that could change. Last month, HEXO announced it's acquiring Newstrike, a premium marijuana grower, for $263 million in an all-share deal. The acquisition will allow HEXO to market marijuana products in 8 of Canada's 10 provinces. It may also signal that it plans to more aggressively pursue deals that can boost its sales, making it more competitive with Aurora Cannabis.

Investments in infrastructure

Aurora Cannabis' marijuana production increased 57% to 7,822 kilos in the fourth quarter, but that only hints at its future production. The company said annual marijuana production capacity should reach 150,000 kilos this quarter, allowing it to have 25,000 kilos available for sale by June 2019. If its existing construction plans stay on schedule at Aurora Sun and Aurora Nordic 2, two state-of-the-art greenhouses, it could add 270,000 kilos of production by the end of 2020.

HEXO's plans are more modest, but it's also pumping up its production. In the three months ending Jan. 31, it produced 4,938 kilos of cannabis, up 39% quarter over quarter. Prior to acquiring Newstrike, it was guiding for expansion projects to increase its annual production to 108,000 kilos. Now, it says peak production will climb to 150,000 kilos per year.

Nevertheless, Aurora's the Goliath with funded-peak production of 500,000 kilos, so unless HEXO spends a lot more money on new facilities or acquisitions, it's going to have a hard time catching up to Aurora Cannabis.

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What's next for these marijuana stocks?

HEXO's goal is to be a top-tier player in Canada and eventually to achieve 2% market share worldwide. If it can deliver on those targets, it could mean billions of dollars in revenue annually. For now, management's guiding for net sales of CA$400 million in fiscal 2020.

Aurora Cannabis hasn't issued forward revenue guidance, but it captured about 14% of Canada's adult-use market in the fourth quarter. Given legal recreational sales were CA$152 million in Q4 and that only represented 20% of total recreational marijuana spending, it's not out of the question that Aurora Cannabis' CA$216 million sales run rate is going to climb rapidly toward the $1 billion mark, allowing it to sustain a significant lead over HEXO.

Turning sales into profit could be a challenge, though. Expenses are skyrocketing at both companies, and lower prices in the recreational channel haven't helped margins. Aurora Cannabis' gross margin, or revenue after considering costs associated with marijuana production, was 52% in the fourth quarter, excluding fair-value adjustments to inventory. That was down from 59% in the same quarter one year ago. The story's similar at HEXO. Its gross margin was 52% in the quarter ending Jan. 31, down from 64% the year prior.

Toss in soaring sales and marketing, general and administrative, and stock-based compensation expenses, and these companies are losing truckloads of money currently. Aurora Cannabis lost CA$238 million in Q4, but $120 million of that figure was from unrealized losses on its investments. Nevertheless, after removing the unrealized loss, its operating expenses were still CA$112 million in Q4, or more than double its net revenue.

HEXO's operating expenses were CA$18.5 million in the three months ending Jan. 31, so HEXO's operating loss was CA$6.9 million for the quarter.

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Is one of them cheaper?

Marijuana stocks have been some of the stock market's best performers over the past two years, so these stocks sport sky-high valuations on traditional valuation metrics, including price to sales and price to book value. Aurora Cannabis and HEXO's price-to-sales ratios, or share price divided by trailing 12-month revenue per share, are nearly identical at 72 and 76, respectively. Aurora Cannabis has an advantage in terms of price-to-book ratio, though. Its price to book, or share price divided by assets minus liabilities per share, is 2.95, while HEXO's is 4.25.

Although HEXO has a significant opportunity to catapult itself into the top tier of marijuana growers, it's uncertain if it will be able to execute effectively. Aurora Cannabis has already established itself as a leading producer. Aurora Cannabis' existing market share advantage, bigger and more accelerated production forecast, and more attractive relative valuation make it the better of these two marijuana stocks to buy right now.

Todd Campbell has no position in any of the stocks mentioned. His clients may have positions in the companies mentioned. The Motley Fool recommends HEXO. The Motley Fool has a disclosure policy.

Stocks Mentioned

Aurora Cannabis Stock Quote
Aurora Cannabis
$1.33 (0.76%) $0.01
HEXO Corp. Stock Quote
HEXO Corp.
$0.17 (-0.75%) $0.00

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