Canopy Growth Vs. Aurora Vs. Aphria: Which Is The Better Buy?

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Includes: ACBFF, APH, TWMJF
by: Jon Ip

Summary

Cannabis stocks have cooled off and now is the time to look into the industry.

Canopy, Aurora, and Aphria are the front runners as we head into 2018 legalization.

There will be short term risk and volatility in production constraints and winter expenses.

Among the three, the top pick is Aurora based on projected revenue growth and projected valuation.

The second is Canopy based on its much larger and steady production capacity and second best revenue growth.

The cannabis industry has been the hot topic for investors for over a year now but the current lull in stock prices and the far away July 2018 legalization timeline has investors wary. Additionally, valuation prices are high and the companies have much to prove. Despite that, it is not too early to invest.

Investment Thesis:

This article is for those who are hopeful of the long-term view and want to get in ahead of time. This article will compare the three front-runners of the Canadian cannabis industry, Canopy Growth Corp. (OTCPK:TWMJF), Aphria (NYSE:APH), and Aurora (OTCQX:ACBFF). Although these companies will soon have to prove themselves in a new environment, there is plenty to study right now. We will be comparing revenue growth, production capacity, valuations, and then making financial projections. The result will be a recommendation of Aurora followed by Canopy. Again this article is meant to compare competitors. The industry has the potential to be a 22.6B industry but the thesis for investing in Canadian cannabis is a separate topic and I encourage you to consider the risks.

Quarter-to-Quarter Revenue Growth:

For these companies, revenue growth is the most significant factor and it is quickly reflected in stock prices as quarterly reports roll out. Below are tables for quarter over quarter growth.

2016-03

2016-06

2016-09

2016-12

2016-12

Canopy

44.84%

38.52%

21.68%

14.76%

$9.7m

Aurora

-

457.07%

151.72%

26.47%

$3.8m

2016-02

2016-05

2016-08

2016-11

2017-02

2017-02

Aphria

32.22%

3.58%

57.63%

19.45%

(2.07%)

$5.1m

*All values here and in the rest of the article are in CAD
*All values here and in the rest of the article are from quarterly reports and MD&A which can be found on their respective company websites or SEDAR.

Quarter-to-Quarter Grams Sold Growth:

Last Quarter over Quarter

Canopy

6.5%

Aurora

23.4%

Aphria

2.0%

The initial takeaway is that Aurora has the strongest revenue growth at 26.47% and that it came from the 23.4% growth in grams sold. This is a very strong story-line.

Canopy had a revenue growth rate of 14.76% and grams sold growth rate of 6.5%. A portion of revenues came from price increases and more sales of premium strains (e.g. higher THC).

Aphria showed a decrease in revenue growth of 2.07% despite a 2% growth in grams sold. Aphria has historically showed unsteady revenue growth, in their 2016-05 quarter, they had a 3.58% growth rate. In their 2016-05 MD&A, they had stated it was because of a limit in production. In their latest 2017-02 press release, they cited "the decrease in revenue for the quarter… was primarily a result of the $8.50 per gram cap placed on the price of medical cannabis for veterans." However, grams sold only growing only 2% leads to believe that they are having another limit in production.

Revenue to Asset Ratio:

Return on equity is used to determine a company's efficiency at generating returns for investors. However, with these companies, since debt to equity ratios change frequently, the return on asset ratio is preferable. Secondly, these companies have little to no earnings at the moment, so we will be using revenue instead of net income. We end up with a revenue to asset ratio and this measures how efficiently the companies use their assets.

Last Quarter ROA

Annualized ROA

Canopy

3.47%

13.90%

Aurora

3.95%

15.82%

Aphria

3.67%

14.71%

Aurora leads in this category as well, followed by Aphria then Canopy. Overall, the difference among companies is not large so ROA is not currently a major factor.

Production and Supply

There is currently a lack of supply in the industry. Each of the three companies have had instances of products being out of stock (particularly high THC strains) and customers are complaining. Companies are ramping up production but there will be a period of time before facilities can come online.

Below is a table that projects the inventory status of the next two quarters, Projected Inventory Q1 and Q2. The aim is to assess which companies are at risk of production constraints.

Beginning Inventory (kg)

Product Harvested (kg)*

Grams Sold (kg)

Grams Sold Growth Rate (%)

Projected Inventory Q1 (kg)

Projected Inventory Q2 (kg)

Canopy

4,520

5,264

1,245

6.5%

8,458.08

12,309.96

Aurora

740

428

538

23.4%

504.11

112.87

Aphria

480

598

652

2.0%

412.76

332.02

*Assume same production capacity in all quarters
*Assume same grams sold growth rate in all quarters

*Numbers in 000's
*Inventory counts dry product only, for relevance, oils are excluded.
*Data from Canopy and Aurora 2016-12 quarterly report and Aphria 2017-02 press release.

Canopy is in the best position with its production capacity. They will be adding to inventory each quarter and they have stated that they will look to sell wholesale opportunistically. Aurora and Aphria, on the other hand, have a quickly declining inventory.

Looking at expansion plan timelines below will help complete the picture and illuminate how precarious the situation is for Aurora and Aphria.

Current production capacity (per year):

Canopy: 30,000 kg dry cannabis

Aurora: 1700 kg dry cannabis

Aphria: 2,500 kg dry cannabis

Future production capacity (per year):

Canopy: 50,000 kg dry cannabis ~ TCanopy Smith Falls ~ expected 9 months

Aurora: 7,000 kg dry cannabis ~ Cremona ~ no announced timeline
Aurora: 100,000 kg dry cannabis ~ Aurora Sky Facility ~ expected 13 months

Aphria: 8,000 kg dry cannabis ~ Phase II Expansion ~ expected 8 months
Aphria: 22,000 kg dry cannabis ~ Phase III Expansion ~ expected 16 months

Included in the expected times are an approximate 3 month Health Canada inspection and approval process and an approximate 3 month growing cycle. These are two major reasons why production cannot be ramped up immediately.

With Aurora, they have not announced the status of Cremona (their main facility). Production may be higher in Q1 and Q2 but we are without information so current projections are that production capacity will be limited at status quo. This would limit their production and consequently their revenue.

With Aphria, it is expected to take 8 months for their Phase II expansion to complete. This means there will be two quarters where they face the same limits in production and revenue. The main takeaway is that production constraints are a real risk for Aurora and Aphria.

Production Cost/Gram:

Canopy

$2.47/gram

Aphria

$2.23/gram

Aurora

$1.96/gram

Aurora is currently the best at managing costs followed by Aphria and then Canopy. This is a factor that will scale in importance as revenues grow.

Aphria's press release explained "during the quarter, our "all-in" costs of dried cannabis per gram increased from $1.79 in the prior quarter to $2.23… the increase largely related to abnormal winter weather conditions in Leamington…" This signals an increase in expenses for Canopy, who is also based in Ontario.

Price to Revenue Ratio

Below is a table a price to revenue ratio. P/R Ratio Q1 and Q2 are projected ratios based on current growth rates.

P/R Ratio

P/R Ratio Q1

P/R Ratio Q2

Canopy

129.95

112.99

98.26

Aurora

140.29

111.02

87.85

Aphria

152.79

155.91

159.09

These valuation are clearly pretty high but future growth is also priced in. At the moment, Canopy has the cheapest ratio. However, if Aurora can continue growing at their current rate of 26%, they are the cheapest after projections.

Next Earnings Dates:

Canopy: June 26, 2017

Aphria: July 6, 2017

Aurora: May 29, 2017

These are dates to be aware of as volatility will be high around these periods and new information will be released.

Brand and Reputation:

At the beginning of the year, Canopy had a recall over pesticide tainted product. The issue appears be settled at this point, any harm in reputation is likely already priced in. On the positive side for Canopy, they are the only company to make significant investments into recreational branding with their "Leafs by Snoop" line. Meanwhile, Aphria and Aurora have focused on only medical. Down the line, this type of branding could be significant as advertising for cannabis will be restricted like tobacco.

The bottom line is that the success of these companies depends on their products. However, unlike iPhones, it is hard to get meaningful product reviews. Company Facebook and Twitter pages aren't reliable sources of community sentiment as they are often managed. There are third-party sites like HealthCannabis that do reviews and on average, Canopy and Aurora have similar review scores of 7-8/10 while Aphria's are slightly lower at 6-7/10. Take this with grain of salt though, those reviews come from a singular source. Lift collects community reviews and there Canopy and Aphria score an average of 4.5/5 while Aurora scores 4/5.

Risks

Investing has its risks, especially in Canadian Cannabis industry. I strongly encourage you to research further.

The first major risk to consider is legalization policy, company operations are subject to a variety of regulations. Health Canada licenses limit who can grow and how much they can sell. They will also decide what kind of cannabis derivatives can be sold such as edibles and vapors. And of course, legalization is not guaranteed.

Second, the industry is just developing. Companies are learning as they go and operations may not always be executed as stated. Companies are focused on quickly expanding and hope to reduce expenses as they mature and consequently have faced a history of losses though they are now becoming fringe profitable.

Third is the nature of agriculture. There are unforeseen factors such as weather and crop failure.

Wrap-up:

All in all, I currently favor Aurora then Canopy. Aurora has the strongest revenue growth, the best projected valuation, and its cost management has proven good so far. However, they do bear the risk of possible production limits in the next few quarters. Canopy is the safe pick with its large scale production and steady revenue growth.

My ending note is that cannabis investors should have a long-term view with July 2018 in mind; short-term volatility is expected and should be kept in perspective.

Disclosure: I am/we are long CANOPY GROWTH CORP.

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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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