Aurora Cannabis Reports Solid Quarter - On Track For Strong Growth

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About: Aurora Cannabis Inc. (ACB)
by: Gary Bourgeault
Summary

Aurora Cannabis almost quadruples revenue as it takes 20% of the consumer market in Canada.

The decline in gross margin should only be temporary - the company reiterates it'll generate positive EBITDA in 2019.

Why disclosed losses don't reflect the operational performance of the company.

Why if you're a shareholder you shouldn't listen to the naysayers. The company will reward those holding for the long term very well.

aurora cannabis earnings report better than expected, revenue and earnings growth outlook is strong

Source: Seeking Alpha

To listen to some of the commentary and reporting on the latest earnings report from Aurora Cannabis (ACB), you would think the sky was falling once again, as many financial writers like to assert on a consistent basis.

Not only do I disagree with that assessment, I think most of them aren't even understanding the fact that the company, via its many investment holdings, is going to continue to be volatile based upon its performance in any given quarter. Aurora must report those holdings as a profit or loss, even though it's only on paper. That's why last quarter the performance appeared strong, even though it was primarily driven by its investment holdings doing better.

In this article, we'll look at why the quarter was a good one for Aurora and why it remains on track to continue to surprise to the upside over the next couple of years. First, we'll look at its earnings report.

Earnings report

Net revenue in the quarter came in at C$54.2 million ($40.75 million), up 363 percent year over year and 83 percent sequentially. Management asserted it took a significant share of the Canadian consumer market with sales of C$21.6 million, accounting for approximately 20 percent of that market.

Total kilograms sold in the quarter were 6,999, up 162 percent.

Gross margins dropped from 70 percent sequentially to 54 percent, with Aurora citing excise taxes, lower wholesale pricing, new packaging requirements and a temporary unfavorable product mix due to the lower price per gram in cannabis recreational sales. Another temporary factor was the increase in optimization costs at its Sky facility as it approaches full production capacity. This resulted in cash cost per gram of dry cannabis rising from $1.45 last quarter to $1.92 in the reporting period.

The company said this about gross margin:

The decrease was primarily due to a lower average selling price per gram of dried cannabis, the impact of excise taxes on medical cannabis net revenues, and a temporarily lower proportion of cannabis oil sales in the company’s sales mix ratio. Also impacting gross margin were increased packaging requirements under the Cannabis Act and one-time ramp-up and optimization costs as our Sky facility was brought up to full production. The company anticipates that the launch of new derivative product lines, once allowed under Health Canada regulations, will contribute to improving margins.

Most important in the report, in my view, was that medical sales in all markets climbed 8 percent to C$26 million, with volume up 23 percent. As I've mentioned a number of times, recreational sales are a nice near-term catalyst for Aurora, but the long-term game is going to be international growth in medical cannabis revenue.

Concerning overall losses, of the reported C$240 million, about C$190 million came from derivative investments. That number is going to fluctuate from quarter to quarter, with some quarters also getting a positive outcome from a stronger cannabis market. That's what happened in the prior reporting period. It's also likely to play a positive role in the next earnings report from the very strong first quarter.

Understanding its investment holdings

Again, Aurora is required to track the performance of its investment holdings as part of its earnings. Whether positive or negative, they're paper losses or gains, assuming the company doesn't sell any of those assets.

For that reason, every quarter could be very different when adding the value of the companies it invested in into its report. How the cannabis industry fares on a quarterly basis will determine the overall performance of the company, even though it isn't part of its operational results.

In my view, this is one of the undervalued and misunderstood parts of Aurora's business. As the cannabis market continues to grow in demand and size, the holdings Aurora has are going to grow nicely with it. Over time, they could be more valuable than the production side of its business.

The key to the company's performance with its holdings is to understand it's all on paper, and for now, their value will rise and fall with the temporary fortunes of the cannabis sector in general. As the market starts to level out in the years ahead, they should start to add consistent value to the company.

Combined with expected growth in revenue and earnings, the combination should push the share price of the company much higher going forward. That is one of the reasons why I'm convinced those holding onto Aurora Cannabis over time are going to enjoy strong returns on their investment.

Just like shareholders shouldn't be concerned about the losses associated with its investments, neither should we get overly euphoric over the gains that come from them at this time.

Conclusion

Management noted that the main growth driver for revenue over the next 18 months or so will be the scaling up of Aurora's production capacity. As the company has guided in the past, it expected to be at about 120,000 kilograms annually in the reporting period, and it confirmed it had reached that target.

By the end of its fiscal fourth quarter (second calendar quarter), Aurora expects to climb to 150,000 kilograms per year. The company has stated recently that in approximately a year's time it should produce over 500,000 kilograms annually. In April to June 2019, its fiscal fourth quarter, Aurora says it should have about 25,000 kilograms available for sale.

With the company reiterating it'll be able to cut costs per gram below $1, and some of the negative catalysts being temporary, things are coming together nicely for Aurora Cannabis and its shareholders.

In the near term, the most important thing to keep in mind is that the bulk of the reported losses is associated with its holdings in other companies. For that reason, it's probable the market could punish the stock, because many only see the headline number without understanding why.

With Aurora continuing on its upward production trajectory, and its proven ability to cut costs out of the operational process, the company is positioned to do very well over the next couple of years.

The most likely challenge, which I haven't talked about much before, is the pace of growth in demand. How quickly it generates revenue from its holdings in Mexico and South America will probably determine the pace of cannabis demand growth for the company. With Canadian recreational cannabis expected to continue to grow at least through the end of 2019, I think it will provide more than enough time for Aurora to accelerate growth in the Latin America market.

With the company reportedly having supply agreements in 23 countries, and beyond Latin America, selling to Poland, Czech Republic and Luxembourg in the last quarter, while recently reporting its first delivery to the UK, the long-term prospects for Aurora Cannabis continue to look very good.

Disclosure: I am/we are long ACB. 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.