Most Canadian cannabis stocks are seemingly expensive today. After all, virtually none are profitable, and most have quarterly revenue under 100 million Canadian dollars. Yet some of these companies have seen their stocks bid up into the multibillions in market capitalization. In fact, Canadian leader Aurora Cannabis (NYSE:ACB) is currently valued at roughly $8 billion, despite making only about CA$75 million in revenue in its most recent quarter.
Of course, the market isn't just looking at today, but ahead to the future. Investment bank Cowen (NASDAQ: COWN) thinks worldwide cannabis sales will hit $75 billion by 2030, while Bank of America (NYSE: BAC) thinks the market could eventually more than double that figure, to $166 billion.
Aurora is gunning to become the largest producer in the world and capture as much of this huge future market as possible. Here's Aurora's big vision looking a few years out.
Scale matters in commodities
Aurora leads all other cannabis companies in terms of potential kilograms produced. In the most recent quarter, Aurora produced 15,590 kilograms, which annualizes to roughly 62,000 kilograms.
But these numbers don't really tell the whole story. The first quarter also saw an inflection in the company's growing capabilities, with production surging nearly 100% quarter over quarter, not year over year. When current and funded capacity comes online, Aurora will be capable of producing over 625,000 kilos of cannabis annually -- roughly 10 times the current production run rate. That leads second-place Canopy Growth (NYSE:CGC) by roughly 100,000 kilos.
The amount of cannabis produced is not merely for the sake of size alone. Aurora is betting its massive scale will drive down costs per gram over time. That's a big deal, since many believe that cannabis will become relatively commoditized, and the lowest-cost producer usually has a competitive advantage in a commoditized market.
While Aurora has also expanded aggressively internationally to 24 countries, it will also export a fair amount from its massive facilities in Canada. That should give Aurora a cost advantage relative to, say, its U.S. competitors, which must have several facilities across different states, because of federal U.S. laws.
On the recent conference call with analysts, management said U.S. growers "have multiple state operators, multistate operators that have small facilities in their various states" and added, "[t]hat's not really the Aurora way of doing things."
Massive, custom facilities make the difference
Management also pointed to the long-term advantage of Aurora's custom-built cannabis grow facilities. These differentiate Aurora from its competitors, which essentially use retrofitted greenhouses. Aurora has thus been able to better control its internal environment and has never had a crop loss.
That's led to industry-leading efficiency. In the March-ended quarter, Aurora drove its costs per gram down from CA$1.92 to just CA$1.42. Again, this change was all in the span of just one quarter. While the company's average selling price also fell, it did so only mildly, from CA$6.80 to CA$6.40 per gram. Overall, the company's gross margin expanded from 54% to 55%.
Aurora's management believes it can drive down costs to "well below CA$1 per gram," as its main Aurora Sky facility ramps up production this year. That would probably be the most efficient growth in the industry and could further buoy margins.
If one factors in all of Aurora's capacity and uses a CA$6 per gram average selling price, Aurora could reach CA$3.75 billion in revenue within a few years, and if the costs per gram continue to drop, the 55% gross margin from the past quarter could potentially expand north of 60%.
Medical- and high-end-focused
But Aurora isn't just about selling commodity flower cannabis at the lowest possible cost. The company is also looking to sell manufactured products at much higher prices. These products will come from the new Aurora Polaris facility, which was just announced in February.
Polaris will focus on manufacturing cannabis from flower produced at the adjacent Aurora Sky facility into edibles, vapes, soft gels, and cosmetics. The two facilities are right next to Edmonton airport, and the company's central logistics and processing hub. Manufactured products help margins because they sell for much higher prices. Last quarter, Aurora's average selling price for cannabis extracts was a whopping $11.01 per gram, compared with just $5.86 for dried cannabis.
Manufactured products are also key to Aurora's focus on the medical market. While many cannabis companies are focused on the faster-growth consumer market, Aurora is focused on the medical community first. That's for a few reasons. One, medical patients tend to buy high-margin manufactured products, and two, medical patients tend to be "sticky." According to Chief Corporate Officer Cam Battley, "Consumers, you never know, but with a medical patient, they're likely to stay with you as long as you keep them happy." Third, it's possible that Canadian excise taxes will be repealed for medical patients in the future. Currently, companies like Aurora pay the excise taxes themselves. Last quarter Aurora paid over CA$10 million in excise taxes alone.
Aurora isn't ignoring the consumer market, either, but is focusing the higher-end organic segment. Organic cannabis, like organic food, is more difficult to cultivate, but it can earn a hefty price premium. Last quarter, Aurora closed its acquisition of Whistler Medical Marijuana, which makes organic, high-end cannabis in Western Canada. Aurora also has a significant minority stake in The Green Organic Dutchman (NASDAQOTH:TGODF), which produces organic cannabis.
Could Aurora be the best?
Best-in-class scale and a focus on high-margin end markets could enable Aurora to become the highest-margin cannabis producer over time. In fact, the company expects to be EBITDA-positive in the upcoming quarter -- a feat unique to many cannabis companies today. Five years out, it appears investors could potentially be looking at a very profitable company, even on a net income basis.
Shareholders also won't have to share the spoils. Aurora is one of the few companies that hasn't taken on a large strategic investor from outside the industry, such as Canopy did with Constellation Brands, or Cronos Group did with Altria. As such, Aurora could wind up looking like the biggest winner in the industry five years from now, although an industry boom could lift many other top players as well.