This November, pot stocks enjoyed renewed interest from investors. In a continuing scramble to see which company will capitalize on the recently legalized "cannabis 2.0" (derivatives) market in Canada, the United States' green wave also showed new life. Last month, voters in four states -- New Jersey, Arizona, South Dakota, and Montana -- cast their ballots to legalize recreational cannabis, and President-elect Joe Biden put decriminalization on his administration's agenda.
Two pot stocks investors are contemplating are Canopy Growth Corp (CGC -4.01%) and Aurora Cannabis (ACB -6.05%). In the past month, both stocks made some investors rich, with the former up 54% and the latter on a monstrous rally that yielded a 154% gain. Many factors are pointing toward further gains for Aurora, and that Canopy may be overvalued. Let's take a look at them below.
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The quick case for Canopy Growth
Let's be honest: Canopy had a blowout quarter in its second quarter 2021, which ended Sept. 30. During this period, the company increased its revenue by a stunning 77% year over year to CA$135.3 million. At the same time, it expanded its gross margins from 5% to 19%. There was also a 57% improvement in the company's free cash flow, declining to a loss of $190.4 million per quarter.
Canopy Growth holds a dominant market share of 54% in the cannabis beverages industry. In addition, it managed to improve its standing in the Canadian recreational cannabis market by increasing its industry weight to 15.5%, a two-percentage-point improvement over first-quarter 2021.
In context, however, Canopy Growth's potential is mostly priced-in. Right now, the stock trades at a whopping 28 times sales, making it one of the most expensive stocks in the entire North American cannabis industry. Those with a value mindset, or those who just don't like to pay a high premium for good growth stocks, should take a look at its cheaper cousin, Aurora Cannabis, instead.
Why Aurora Cannabis is better
Aurora Cannabis' stock is very oversold. In 2019, the company expanded its production capacity to over 500,000 kilograms of cannabis per year. As of Q1 2021 (ended Sept. 30), however, the company found there was only demand for about 64,000 kilograms of its pot each year. Due to dramatically miscalculating the supply-and-demand balance of Canada's legal cannabis market, Aurora had to write down billions in losses on its assets.
One thing that amazes me about Aurora, however, is the speed of its turnaround. After a series of facility closures and lay-offs, Aurora is on track to resize its operations. In Q1 2021, its revenue decreased slightly to CA$67.8 million. However, the company managed to post an adjusted gross margin of 52%, far better than Canopy Growth's 19%.
Aurora cut its sales, general, and administrative (SG&A) expenses from CA$100 million per quarter to CA$43 million per quarter within the span of a year. Its operating loss adjusted for non-cash items (EBITDA) stands at only CA$10.5 million.
These cost-cutting measures are working well. They are aided by the fact that Aurora is slowly realizing new sales potential. In May, the company acquired U.S. cannabidiol (CBD) producer, Reliva. This subsidiary holds the top-selling cannabinoid topical cream and the second most popular CBD brands overall (by some measures) in the nation. Before its acquisition, Reliva brought in about $10 million per year in sales.
Reliva's products are available online and in over 20,000 retail locations. Nearly half of America's biggest convenience stores sell the company's CBD. As more and more states join the legalization bandwagon, one should expect Reliva's sales (and, by proxy, Aurora's) to accelerate in the near future.
The biggest edge Aurora has over Canopy Growth is its valuation. Right now, the company only trades at 5.9 times revenue and 1.2 times net assets. As its U.S. revenue segment improves and its Canadian operations bleed less and less cash, I'd expect Aurora stock to rally sharply and enrich investors much more than Canopy Growth.
