In recent weeks, Aurora Cannabis (ACB 12.87%) stock has seen new life. It all started with the company releasing its third-quarter 2020 results on May 14, which showed 18% revenue growth from the prior period. A commitment to further improving its costs also gave investors a reason to be hopeful that profitability may not be just a pipe dream.
Then, on May 20, the cannabis producer also announced it was acquiring Reliva, a cannabidiol (CBD) brand that would allow it to penetrate the U.S. market. As exciting an opportunity as that may seem at first glance, here's why investors shouldn't put too much stock in it.
It's entering an already crowded hemp market
Many headlines advertise Aurora's recent acquisition as the company getting into the U.S. CBD market. While it's technically true, it deserves an asterisk at the very least. All forms of CBD aren't legal in the U.S. (federally), and Aurora can't offer non-hemp products that contain more than 0.3% of tetrahydrocannabinol (THC). However, U.S. cannabis companies that don't operate nationally and instead operate within states that allow medical or recreational pot aren't limited to those constraints. And until the U.S. government legalizes medical or recreational marijuana, it's a limitation Canadian cannabis companies will face.
Image source: Getty Images.
The good news is that according to research companies BDS Analytics and Arcview Market Research, the total CBD market in the U.S. is still expected to reach $20 billion by 2024, up from just $1.9 billion in 2018. The projection didn't break out the split between hemp and non-hemp products. And the bad news is that the rosy outlook for CBD doesn't mean the opportunity is going to translate into significant growth for Aurora.
That's because Aurora will not only be competing with other U.S. companies for market share, but with Canadian pot stocks that are also looking to take advantage of the opportunities in the hemp market. The company's key rival, Canopy Growth (CGC 20.65%) is already in the CBD hemp market in the U.S., and one of the moves it's making to cut costs is to actually stop farming for hemp at its Springfield, New York location. The pot giant said it had "an abundance of hemp produced in the 2019 growing season" that it was going to sell first before making more. It's not just Canopy Growth that has an excess of supply, either; it's a problem for the entire industry.
Julie Lerner, who is CEO of the PanXchange where hemp is traded, confirmed in January that there was much more supply than demand for hemp. She expects retail prices to come down as a result of all the competition. That's not going to bode well for a company like Aurora, which is trying to improve on its margins and get closer to profitability.
Having access to thousands of locations doesn't guarantee growth
In the news release announcing the acquisition of Reliva, there wasn't a whole lot of information on how big of a player the company is in the hemp market. Although Aurora referred to Reliva as "a leader in the sale of hemp-derived CBD products in the United States," there wasn't anything to quantify or justify that other than to say that its products were sold in more than 20,000 U.S. locations. According to analysts, Reliva's sales over a 12-month period ending in February totaled $14 million in revenue.
Hemp-derived CBD company Charlotte's Web (CWBHF 1.30%), sells its products in fewer locations, and it has far stronger sales. In the company's first-quarter results, released on May 14, Charlotte's Web announced that its reach surpassed 11,000 locations and that its sales for the three-month period totaled $21.5 million. And although it's seen an increase in the number of stores carrying its products, that hasn't translated into significant growth.
A year ago, the company recorded sales of $21.7 million when its products were in more than 6,000 locations. The increase in locations over the past year hasn't resulted in a surge in sales for Charlotte's Web, and Aurora investors shouldn't make the mistake of assuming more locations mean greater revenue. If there are only limited products available, or the inventory isn't moving, the number of retailers carrying the products may not mean much for the company's top line.
The move doesn't make Aurora a better buy
Aurora expects Reliva to help the Alberta-based pot producer inch closer to achieving a positive adjusted earnings before income, taxes, depreciation, and amortization (EBITDA) figure. However, with Aurora incurring an adjusted EBITDA loss of 50.9 million Canadian dollars in Q3, it has a long way to go to reach breakeven, with or without Reliva. The acquisition may help play a small part in improving Aurora's bottom line, but the company still has a lot of work to do in improving its financials.
The only certainty, it seems, is that the deal will lead to more dilution for shareholders. The companies anticipate the deal will close in June, and it will cost Aurora as much as $45 million in shares.
The acquisition is a modest one for Aurora that will help add to its top line, but that's about it; Aurora remains a risky buy, and one quarter and one acquisition isn't going to change that. The pot stock is still down more than 80% over the past 12 months, notably worse than the Horizons Marijuana Life Sciences ETF (HMLSF 0.62%), which has fallen by 60%.
