Welcome to our Cannabis Earnings series where we break down the latest earnings to help you focus on the most important topics.
Aurora Cannabis (ACB) reported its second-quarter fiscal 2019 results on Monday after the market closed. The company already pre-announced its revenue a few weeks ago and we have analyzed the guidance in "Q2 Guidance Fell Short Of Expectations." The biggest takeaway coming out from this quarter was the pressure on gross margin and Aurora's struggle to become profitable in the near term. We think the only way to close its valuation gap with Canopy (OTC:CGC) and Cronos (OTC:CRON) would be a partnership with an established beverage or tobacco player.
(All amounts in C$)
After Aurora management guided net revenue of $50-55 million a few weeks ago, the actual revenue came in at $54.2 million which is at the top end of the guidance. Management for the first time separated $2.6 million of the services revenue, which came from Aurora's various subsidiaries. The revenue should come as no surprise to investors but what is a little concerning is the substantial drop in gross margin. Overall gross margin dropped from 68% to 52% this quarter, largely due to the gross margin from selling cannabis dropping from 70% to 54%. The drop in gross margin was a result of the excise tax on medical cannabis sales, lower realized wholesale prices in the recreational market in Canada and lower oils in the overall mix. Aurora incurred higher packaging costs and one-time costs related to its Aurora Sky facility, which is now fully commissioned and waiting for Health Canada inspection. Overall, the drop in gross margin is concerning but well expected, given lower wholesale prices for recreational sales.
Aurora sold a total of 6,999 kg of cannabis during the last quarter, which is a substantial increase from the prior quarter. Recreational sales accounted for $21.6 million of the total revenue which implies that the medical business has stagnated. The patient count grew 9% to reach 73,579 but the introduction of the excise tax on medical cannabis sales pressures medical sales which is more expensive. Many patients are exploring the recreational market as an alternative due to their lower prices and similar offerings.
Canada accounted for the bulk of the revenue with sales from the EU coming in at $3.2 million, mainly from Germany. Cash cost increased $1.92 per gram due to the ramp-up at Aurora Sky. Aurora harvested a total of 7,822 kg of cannabis in the last quarter and we expect production to increase substantially once the 800,000 sq ft Sky facility becomes fully licensed. Management estimated that its $21.6 million of recreational sales represent 20% of all Canadian sales which would imply a total Canadian market of $108 million, a very low number. To get a sense of Aurora's market share in Canada, below are LPs that have reported recreational sales:
- Aphria (OTC:APHA) reported total sales of $21.7 million last quarter including $8.4 million from the recreational market between October and November
- Organigram (OTCQX:OGRMF) reported $9.2 million in sales from the recreational market between October 17 and November 30
- HEXO (OTCPK:HYYDF) reported $5.2 million in recreational sales for the last two weeks in October 2018
Losses from operations totaled $80 million as revenue remains a fraction of the expenses incurred last quarter. During the 6 months ended on December 30, 2018, Aurora lost $133 million of cash from operations but the company appears well-funded given its recent US$350 million convertible debt issuance.
At the end of last quarter, Aurora reported $700 million from its investments in a number of companies as we discussed in "Demystifying Aurora's $700 Million Investment Portfolio." However, due to the significant declines the cannabis market experienced during the last quarter, Aurora's investment portfolio shrank more than 50% to $318 million:
- Marketable securities declined from $346 to $117 million
- Derivatives declined from $158 to $69 million
- Investment in associates declined from $201 to $132 million
A large part of the declines was due to the declining share prices of Alcanna (OTCPK:LQSIF) and Green Organic Dutchman (OTCQX:TGODF). During the quarter, Aurora sold 6.3 million TGOD shares for proceeds of $36 million. As we discussed in "Aurora Should Dump Its Remaining TGOD Shares," Aurora sold another 4.5 million shares in January thereby reducing its stake in TGOD to 28.8 million shares.
During the fourth quarter, Aurora has made significant developments in several fronts including M&A and capital raising.
- Aurora began trading on the NYSE
- Aurora acquired the privately-held Whistler Medical Marijuana for C$175 million in an all-stock deal in an effort to beef up its organic offering targeting the premium market.
- Aurora raised US$345 million by issuing convertible debentures; Aurora became the second large Canadian company to tap the U.S. private placement market after Tilray (NASDAQ:TLRY) raised US$450 million
- Aurora made two investments in cannabis retailers including $20 million investment in Choom (OTCQB:CHOOF) and $10 million in Hign Tide
- Aurora entered the Mexican cannabis market by acquiring Farmacias Magistrales S.A. for an undisclosed amount
- Aurora expanded its market reach in the EU with its shipment into Poland, the Czech Republic, and Luxembourg.
Despite the pre-announced revenue figures, investors still learned about Aurora's latest developments and its positioning in the Canadian cannabis market. Management has made it clear that the Canadian recreational market will continue to pressure its margin and it is prioritizing its sales to focus on the high-margin medical and international markets. Aurora's recent acquisition of organic producer Whistler Medical Marijuana is yet another sign that the company is looking for ways to obtain higher selling prices. However, we think the biggest question that investors should ask is whether Aurora is becoming one of the least exciting cannabis companies as it looks increasingly like a farmer. Aurora's peers have most pivoted into other product categories through direct investments and partnerships such as Canopy/Constellation (NYSE:STZ), HEXO/Molson (NYSE:TAP), and Cronos/Altria (NYSE:MO). Aurora does not have partnerships for the beverage and pharma markets which means that it will face an uphill battle while it tries to develop these products independently. For example, having an established brewer as a partner would mean day and night for the development of cannabis-infused drinks, one would think.
We think this quarter holds little surprises in terms of the financial results as Aurora already pre-announced the revenue. However, the declining margin and management's pessimistic view of the recreational market in Canada is not helpful to instill investor confidence. Aurora does not benefit from an established partner so its focus on growing and selling cannabis has actually resulted in lower valuation in the stock market. Aurora has bought dozens of companies but few of them generate any revenue. In order to obtain higher valuation, we think a partnership with an established industry player could be instrumental. Otherwise, the market will continue to value Aurora closer to a grower that is facing a challenging market in Canada.
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.