After the recent slump in the cannabis sector, the valuation gap between Aurora Cannabis (ACB) and Canopy Growth (CGC) has narrowed significantly. However, between these two of the largest cannabis companies in the world, we think Canopy remains a better investment at this time. Canopy’s valuation premium over Aurora is justifiable as financial and funding risk will become more important during a prolonged industry downturn.
(All amounts in C$)
Aurora is Cheaper
If you follow the cannabis sector, you will know that the industry is experiencing one of the deepest and longest selloffs in its recent history. By conventional valuation standards, both Aurora and Canopy still trade at hefty multiples but the premium observed in Canopy shares has dissipated to ~7x EV/Sales (Canopy used to be twice as expensive as Aurora). The two companies represent two of the largest cannabis players in Canada by market value which means that investors are constantly debating whether one represents a better investment than the other.
(Source: Public Information)
It is incredible that the two companies have performed right on top of each other during the last year. The two stocks moved in lockstep and followed each other on their way down. During the last several months, the entire cannabis sector has been hit hard with a string of bad news. Both companies have dropped around half of their equity value but Canopy’s valuation collapsed further due to bigger financial improvement made by Aurora in the last quarter.
Why Canopy Trades Higher?
Canopy still trades at a premium to Aurora and many other LPs. We believe there are three main reasons that could explain Canopy’s higher trading multiples compared to Aurora. First of all, Canopy has $3.1 billion of cash sitting on its balance sheet which came from the $5 billion investment made by Constellation in 2018. Canopy has the single highest cash balance in the industry which provided it with unparalleled access to investment opportunities including large-scale M&A targets such as Acreage Holdings (OTCQX:ACRGF). The company could also invest in key growth areas including its ongoing investment in the U.S. to build out a hemp industrial park.
Secondly, the Constellation affiliation also contributed to the premium valuation because one of the largest beverage companies has cast a vote of confidence in Canopy which is a bullish sign. Despite the recent struggles and the abrupt firing of company founder Bruce Linton, we think Constellation remains a valuable strategic partner and large shareholder. A near-term catalyst for Canopy would be the appointment of seasoned CEO which would revive investor confidence in the global cannabis leader.
Lastly, Canopy was one of the earliest cannabis companies in Canada and rose to fame through its $430 million acquisition of Mettrum, which was the largest cannabis M&A deal at the time. Aurora only became well-known through its 2017 acquisitions of CanniMed and MedReleaf and its barbarian approach resulted in several legacy issues that continue to weigh on its share price. We believe that Canopy assets are better integrated compared to Aurora and its pristine balance sheet and dry powder deserve a premium valuation especially during today’s challenging financing market for cannabis companies.
Why Aurora Trades Lower?
Aurora rose to fame after it targeted CanniMed through a hostile acquisition but the MedReleaf acquisition was not very well-received. The stock price has been suffering from stagnation since the MedReleaf acquisition and the recent selloff knocked the stock back to levels last seen in November 2017. Going forward, we think there are two reasons why the stock could face additional headwinds compared to its better-capitalized competitor Canopy.
First of all, Aurora could face difficulties funding its remaining constructions especially given the tough markets recently. The company had $316 million of cash available in June but it is still at least one year away from completing its two remaining large greenhouses (Nordic 2 and Aurora Sun). We think the company will continue bleeding cash for the next 12 months and its cash pile will soon dwindle to dangerous levels that could force an unfavorable financing event for existing shareholders.
Secondly, Aurora has used equity dilution aggressively to pursue its acquisitions. For example, the MedReleaf deal was all-stock which resulted in its share count ballooning to over 1 billion shares. The large share count also resulted in a widely-held shareholder base that includes a large retail shareholder base. After the NYSE listing, the stock became easier to short which is negative for the stock in a down market. Compared to Aurora, Canopy enjoys more institutional support and its cornerstone investor, Constellation, provides a certain level of comfort and assurance to other investors.
Aurora and Canopy remain two of the largest cannabis companies in the world but the two stocks trade at vastly different multiples on an annualized revenue basis. Canopy benefits from its Constellation affiliation, $5.3 billion cash balance, and prestige from being one of the earliest cannabis pioneers in Canada. Aurora, on the other hand, showed up later but reached its current size through aggressive acquisitions that also caused significant shareholder dilution along the way. We think the premiums observed in Canopy shares are justifiable assuming that you believe in the value of having Constellation as a large investor and that its $3 billion cash pile is a competitive advantage. For Aurora, the company needs to prove that it could create value from its past acquisitions and that the capital spendings on several enormous greenhouses around the world will be worthwhile.
For now, against the backdrop of a prolonged selloff in the cannabis sector, we think Canopy remains the better choice given its staying power and its backing from Constellation. Aurora’s ongoing spending on large greenhouses and a small cash balance could spell trouble for the producer if the Canadian market becomes oversupplied within the near future.
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.