Few if any industries offer the long-term growth potential that legal cannabis brings to the table. After delivering almost $11 billion in sales last year, the State of the Legal Cannabis Markets report from Arcview Market Research and BDS Analytics calls for more than $40 billion in worldwide revenue by 2024. That's a healthy compound annual growth rate of about 25%.
At the top of the list of marijuana stocks to buy for most investors is Aurora Cannabis (NYSE:ACB). Currently the third-largest pot stock by market cap, and the most widely held stock on the planet, according to millennial-focused investing app Robinhood, Aurora offers investors a lot of intrigue.
Why are pot stock investors obsessed with Aurora Cannabis?
For starters, no marijuana stock on the planet has the ability to produce as much cannabis as Aurora. Spanning the company's 15 grow sites, it could have the potential to produce as much as 700,000 kilos a year. It's also worth adding that Aurora's larger grow sites should offer impressive efficiency. For example, when Aurora Sun is fully operational, it'll be yielding at least 230,000 kilos annually from 1.62 million square feet of growing space. That's 142 grams per square foot. Comparably, most growers can hope for 75 grams per square foot to 125 grams per square foot, at their peak.
Investors also have to like Aurora's geographic breadth. No cannabis producer has a cultivation, research, export, or partnership presence in more countries (25) than Aurora. Having witnessed how oversupply and commoditization have hurt select recreationally legal U.S. markets, it's assumed that Aurora will utilize these overseas channels to move excess Canadian supply. Plus, with 132,000 kilos of peak output located in Europe, it already has easy access to that region's burgeoning medical marijuana industry.
That's another point not to overlook: Aurora Cannabis is focusing on higher margin medical marijuana patients. Even though the recreational market has a larger pool of consumers, medical patients have been shown to use pot products more often, buy more frequently, and purchase higher-margin derivatives -- a derivative is a non-dried-flower product, such as edibles, vapes, and infused beverages.
Sounds like the perfect investment opportunity, right? Well, not so fast. Most marijuana investors are overlooking three core growth concerns that, ultimately, damage the Aurora Cannabis investment thesis.
1. Persistent supply issues will keep high-margin products off the market
To begin with, investor expectations for Aurora Cannabis probably aren't accounting for the severity of supply issues currently impacting Canada. Though investors might be aware of persistent dried flower supply challenges since day one of legalization on Oct. 17, 2018, they're likely overlooking the remaining hurdles that Aurora and the entire industry will need to overcome.
What hurdles, you ask? Regulatory agency Health Canada has been absolutely buried under cultivation and sales licenses applications for more than a year now. Even with the agency implementing changes to the grow license application process, there's little chance of Health Canada ridding itself of this backlog anytime soon.
Further, certain provinces have been slow to approve licenses for physical dispensaries. Without physical locations to sell cannabis, consumers have had no choice but to turn back to illicit markets.
The real issue here is that these supply issues coincide with the launch of marijuana derivatives. The expectation has been that these higher-margin alternative consumption options would drive cannabis growers like Aurora to profitability. And while this might, indeed, be the case, the same concerns that have impacted dried flower are liable to be a nuisance to the derivative space. This pushes the expected impact of derivatives out further than anyone had predicted.
2. International sales are going to take years to bloom
A second reason the Aurora Cannabis investment thesis goes up in smoke is the company's reliance on international markets for its success. While there's no denying that these external sales channels will come in handy many years down the road, the company's international investments simply aren't going to pay off anytime soon.
In the view of Health Canada, it's always been assumed that growers wouldn't begin exporting a substantial amount of their product to overseas markets until Canadian consumer demand was satisfied. But as was established in the previous point, it could take a while before Canada resolves its supply issues and gets the appropriate product (dried flower and derivatives) on retail shelves to meet consumer demand.
In other words, Aurora has made substantial investments overseas, but won't see much in the way of payoffs from these investments for years.
3. A writedown looks likely
Finally, if would-be investors of Aurora overlook the company's balance sheet, they could be in for an unwelcome surprise.
Aurora has long considered acquisitions an important part of its long-term growth strategy. Since August 2016, Aurora has made well over one dozen purchases, including the buyout of grower MedReleaf, which tipped the scales at $2 billion. Unfortunately, these acquisitions have also led to the recognition of quite a bit of goodwill on the company's balance sheet.
In layman's terms, goodwill represents the premium that Aurora paid to acquire other businesses, above and beyond tangible assets. Ideally, Aurora will be able to build out the infrastructure of its acquired assets, monetize any intellectual property that it acquired, and completely recoup all of its goodwill. But given that Curaleaf just amended one of its largest acquisitions due to changing market conditions in the U.S., it's a near-certainty that Aurora overpaid for many, if not all, of its deals.
As of the end of Aurora's fiscal 2019, it was carrying 3.17 billion Canadian dollars of goodwill on its balance sheet. This represents a staggering 58% of its total assets, and is by far the highest number among pot stocks. In my view, it's increasingly likely that Aurora will take a sizable writedown on its goodwill in the not-so-distant future.
There may come a time when Aurora Cannabis becomes the attractive buy that optimists believe it to be, but for the time being the company's investment thesis is damaged.