It’s obvious that Aurora Cannabis (ACB) management jumped the gun in August when it gave guidance based upon unaudited data. The failure to meet its own guidance resulted in the appearance of vastly under performing, even though the numbers in the last reporting period, for the most part, were solid.
In this article we’ll look at the near and long-term implications of the latest results on the company, and why the positive narrative, over the long haul, remains in place.
Key metrics were solid
Almost every key metric in the quarter enjoyed a significant increase in improvement.
Net cannabis revenue jumped to C$94.6 million, a gain of 61 percent over the prior quarter. Revenue from Canadian consumers finished at C$44.9 million up 52 percent. Medical cannabis revenue closed the quarter at C$29.7 million, an increase of 10 percent. Wholesale revenue was at C$20.1 million for the quarter.
Production volume in the reporting period reached 29,034 kilograms, up 86 percent sequentially. Cash cost per gram dropped to C$1.14 per gram, a 20 percent decline from the previous quarter. Gross margin improved by 3 percent to 58 percent sequentially. Adjusted EBITDA had a loss of C$11.7 million, shrinking by 68 percent from the C$36.6 million in the third quarter of 2019.
One key number that was down was the net selling price of cannabis, which dropped C$1.08 per gram to C$5.32 per gram sequentially. That was attributed to the increase in wholesale and recreational revenue as a percentage of sales. Not long ago the company had a more favorable product mix, with medical cannabis accounting for about 50 percent of all sales.
Once derivatives start to sell, which will have impact in the first calendar quarter of 2020, that should significantly improve margins and earnings for Aurora.
As for medical patients, its base climbed 10 percent to 84,729 from the third quarter.
In August Aurora came out with guidance that it was on track to generate $100 million in net revenue in the fiscal fourth quarter, along with reinforcing past assertions it was very close to positive EBITDA, and should reach it in the fourth quarter. Neither of them came about, and the company experienced downward pressure on its shares immediately afterward.
A peculiar thing about the initial reason given for the failure to meet expectations was the low number of retail outlets in Canada that sell cannabis. While that’s true, the problem is the company knew this at the end of June 30, so it’s puzzling as to why that was given as the reason for the failure to meet August guidance.
Aurora’s Chief Corporate Officer Cam Battley actually said the same in a recent interview on Yahoo Finance. He said this:
If you take a look at our core business, our cannabis businesses, we came in exactly where we guided for which was between C$90 [million] and C$95 [million] and we came in at C$95 million.
In other words, in its core business the company didn’t miss guidance, but then asserted the reason for missing was the limited number of retail outlets to sell through. That’s specifically related to its core business.
Later on Battley notes that weakness in its construction division and analytics testing labs unit was the reason behind the overall miss.
I’m not simply being pedantic here. It’s important to understand what’s happening, and the conflicting reasons given could confuse investors.
My conclusion is the company continues to misspeak on the matter by referring to its data earlier in 2019, extrapolating that over the current conditions. That’s why on one hand the company says a lack of retail outlets were behind the weak performance, and on the other hand says its core cannabis business met guidance. Both can’t be the truth.
Add to that the fact the construction division and analytics testing labs unit were cited as the reasons for the miss, and there are obvious contradictions being stated.
What that suggests is the company based its August guidance on old data that no longer applied. Management knew the number or retail outlets remained low in number in Canada, but still presented the August data as if it had changed to the better.
The point of all of that is to understand that the construction division and analytics testing labs unit were reason behind the miss, and not the lack of retail stores.
The relatively small number or retail stores in Canada remain a big problem, but not for this particular quarter.
Not everything is under their control
At times companies can make excuses for poor performances when not meeting expectations, but in the case of Aurora Cannabis pointing to there being far less retail outlets than the Canadian cannabis industry needs to meet demand, it is an accurate assessment.
The two major problems undermining Aurora and other Canadian-based pot companies has been the failure of companies that produce packaging that is compliant with regulations to deliver at expected levels, and the above-mentioned low number of approved of outlets to sell pot out of.
This is especially important in Ontario and Toronto in particular, which up until recently, literally only have a small number of places people could buy pot. Obviously there and other provinces and cities consumers decided to continue to buy from the black market to meet demand.
I keep hearing some pundits and analysts suggest the Canadian market isn’t experiencing the type of cannabis demand that was being looked for, but that has nothing to do with it at all. The demand hasn’t suddenly dried up after legalization in October 2018.
Recently I wrote this about the lack of retail outlets in Ontario and Toronto:
… the province of Ontario has between 14 million and 15 million people at this time, and less than 25 retail outlets serving it. That accounts for between 38 and 39 percent of the Canadian population. The city of Toronto only has 5 retail stores people can get cannabis from.
That is rapidly going to change after a recent lottery that will add another 13 stores in the city of Toronto and a total of 42 in the province (including the Toronto stores).
But even with those additional stores, which will help, it’s still far below the number that should be serving the area. This is hindering all the cannabis companies selling in the region and Canada as a whole, and that has a disproportionate impact on Aurora because of the amount of supply it is producing.
The point is Aurora management is accurate in saying it is a key factor in its results, but as mentioned earlier, not in relationship to the most recent quarterly numbers as it related to guidance.Until this is straightened out, investors need to take the low number of retail outlets in Canada as a factor in expected performance results. This is especially true with Aurora Cannabis because of the amount of its supply.
By an measure Aurora Cannabis had a great quarter. The company temporarily became its own worst enemy by providing guidance based upon assumptions made earlier in 2019.
Since it was obvious the rolling out of retail outlets was going to continue to go slow, it should have revised its expectations accordingly. That in turn resulted in the company appearing to generate a weak quarter, when in fact it was an excellent performance.
It also didn’t help to have seemingly conflicting reasons given for the quarterly outcome, when it was primarily from weak numbers in its ancillary businesses; it suggested cannabis revenue failed to meet expectations, when it came in at the top level of guidance.
For the long term, the company is correct in saying the lack of retail outlets in Canada are hurting its potential. That needs to be taken into account when making short-term projections. In the long term, this will work its way out and Aurora Cannabis will get the full benefit of its production capacity as it relates to the Canadian market.
After the first calendar quarter of 2020, it should also show significant improvement in revenue, margins and earnings, as it will have a full quarter of selling derivatives in Canada.
I remain bullish on Aurora, and consider this an opportunity to buy up shares at a good entry point.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.