Since the beginning of 2019, few industries have generated buzz quite like the marijuana industry. The Horizons Marijuana Life Sciences ETF, the first tradable cannabis exchange-traded fund, is up 49% for the year through Monday, May 6. That almost triples the 17% return of the broad-based S&P 500 since the year began.
Becoming enamored with the pot industry is easy when Wall Street continues to throw around huge sales projections. Although the weed industry "only" generated $12.2 billion in legal global sales in 2018, it looks to be on pace for $50 billion to $75 billion in annual revenue by the end of the next decade. Meanwhile, Christopher Carey at Bank of America recently opined that peak pot sales could hit $166 billion a year, as well as disrupt industries that currently total $2.6 trillion in annual worldwide revenue.
And you wonder why marijuana stocks have done so well?
Image source: Getty Images.
Pot stock investors flock to Aurora Cannabis
Perhaps no pot stock is more popular than Alberta-based Aurora Cannabis (ACB -1.15%), which is the crowned favorite among millennial investors. Aurora Cannabis brings a number of competitive advantages to the table that's made it a common selection among investing enthusiasts. For starters, it's expected to lead its peers in terms of peak production potential. The company currently calls for more than 625,000 kilos of peak annual output by the midpoint of 2020, but I find this projection to be conservative. Inclusive of its ICC Labs acquisition in South America, well over 700,000 kilos seems likely.
In addition to simply producing a lot of marijuana, Aurora has done a killer job of moving into international markets via production and/or distribution deals. Including Canada, Aurora has a presence in 24 countries, which leaves even well-established players like Canopy Growth and Aphria well in the distance. These overseas sales channels will come in particularly handy if and when dried cannabis flower becomes oversupplied and commoditized in Canada. Should this happen, Aurora will have numerous overseas sales channels to reduce or eliminate any domestic excess supply, removing the possibility of serious margin degradation.
Also, don't forget that Aurora's "secret weapon" is that it's chosen to focus on the medical marijuana market, as opposed to the much larger recreational consumer pool. Although this means giving up on some low-hanging fruit, the decision should lead to higher and more consistent margins. That's because medical pot patients use marijuana more frequently, buy product more often, and are considerably likelier to purchase high-margin derivatives, such as oils, than adult-use consumers.
Add this up, and couple it with the growing likelihood that Aurora Cannabis will find a brand-name partner now that it's hired billionaire activist investor Nelson Peltz as a strategic advisor, and it's easy to see why investors have rallied around Aurora.
Image source: Getty Images.
Don't look now, but revenue forecasts for Aurora are tumbling
But just because the investment community has flocked to Aurora, it doesn't mean everything is running smoothly. Well-known supply chain issues in Canada are wreaking havoc, and it's the most prominent growers, like Aurora, that could pay the price.
On Monday, GMP Securities, which rates Aurora as a buy with a price target of 15 Canadian dollars ($11.15 U.S.), substantially cut its sales forecast for the company ahead of its third-quarter earnings release next week, as well as reduced its fiscal fourth-quarter revenue projection. According to MarketWatch, GMP analyst Martin Landry lowered his firms' fiscal third-quarter revenue estimate to CA$74 million ($55 million) from CA$91 million, and slashed Aurora's fiscal fourth-quarter sales forecast to CA$132 million ($98.1 million) from CA$150 million. Said Landry:
This is to reflect the low sales volumes reported by Health Canada in the recreational channel for January and February of 2019. We continues to believe that the main reason for the limited sales growth is the cap that has been placed on the retail network by the provincial regulators, limiting the number of cannabis stores and hindering black market penetration.
Landry would go on to note that Aurora had a more-than-25% share of in-stock SKUs in recreational weed stores in Ontario, Quebec, and Alberta, which make up nearly three-quarters of the Canadian market.
Image source: Getty Images.
It's time to rein in those lofty expectations
For those unfamiliar, Health Canada was buried by a stack of more than 800 licensing, processing, and sales applications, as of January. In many instances, it can take months or years to review and approve these applications. There have also been delays in opening dispensaries at the provincial level, which have reduced supply.
Building on the regulatory red tape, there's also been a notable shortage in compliant packaging solutions. Health Canada laid out a laundry list of requirements that retailers would need to abide by if they wanted their products on dispensary store shelves. This included tamper- and child-resistant packaging, clear warning labels, minimal branding, and no packaging that would purposefully appeal to adolescents. This long list of guidelines has created a shortage of compliant packaging, which has left raw cannabis on the sidelines awaiting processing.
Long story short, these are issues that will take time to work through. Even Aurora is still in the process of completing construction on numerous greenhouse projects, and we likely won't see a full ramp up of global production for a good two years. As much as investors would like to believe that the sky is the limit for marijuana stocks like Aurora Cannabis, the glass ceiling may prove a little close for comfort over the next couple of quarters.
