Why A High Valuation For Aurora Cannabis Makes Sense

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ACB
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Pot stocks have been on a roll post a vote in the Canadian parliament on June 19 to legalize recreational use, which will come into effect in October of this year. Growth in their shares is reminiscent of the high returns seen in tobacco stocks such as Altria (NYSE:MO) in the last 20 years. Aurora Cannabis (TSE: ACB) is one such company, benefiting from the surge in the stock prices, which, like other pot companies, has been scrambling to increase its production capacity to meet the high demand forecast. Not only is the company building out its own capacity, it has also undertaken the acquisition of a few smaller players in the market. Post a $1.1 billion acquisition of Cannimed, Aurora announced the purchase of MedReleaf (TSE: LEAF) for roughly CAD 3.2 billion ($2.5 billion) in May in an all-stock transaction, making it the biggest marijuana deal till date. As per an estimate by CIBC World Markets, the recreational cannabis market in Canada could be valued at anywhere between $5 billion and $10 billion per year.

We have created an interactive dashboard analysis to estimate Aurora Cannabis’ valuation based on its expected revenues for FY 2018 (year ended June 30, 2018 – results are yet to be announced). If you disagree with our forecast, you can make changes to these variables to arrive at your own price estimate for the stock.

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We have arrived at a CAD 9.73 price estimate for Aurora Cannabis based on revenue projections of CAD 62 million for 2018, a P/S multiple of 75, and a share count of 479 million. The market price stood at CAD 9.03 as of July 11, 2018, implying our price estimate is higher by 8%.

The P/S multiple in this industry has been considerably high, given the tremendous growth expected in the coming years. Investors have been willing to buy the shares of pot stocks at significant premiums, with other companies in the space garnering P/S multiples touching 100. Moreover, with the addition of recreational marijuana use, the revenues for companies like ACB should grow immensely from FY 2019 onward.

Besides growth in the overall medical cannabis market, there are a number of other factors that should result in a rise in both the cannabis revenue drivers – grams sold and average price per gram – as well as growth in other revenues.

1. Capacity Expansion: At the end of June 2018, the Aurora Vie production facility in Pointe-Claire, Quebec, was granted its Health Canada sales license. The fully-operational facility is on target to produce at a rate of 4,000 kg per year of high-quality cannabis by October 2018. Another facility, Aurora Sky, is on track towards full operation in late summer. Once it completes its second harvest in July, the company will apply for the license for the facility, which has a capacity of over 8,000 kg each month.

2. Key Acquisitions And Strategic Investments:

  • In September 2017, the company completed the acquisitions of BCNL and UCI, both of which are involved in the production and sale of systems for indoor cultivation of cannabis. This will help ACB cater to the home gardening market in Canada, where roughly 11,000 people are registered to grow either their own cannabis or as designated growers for others.
  • In March 2018, ACB acquired CanniMed, creating a combined entity with more than 45,000 active registered patients, 7 EU GMP certifiable facilities, and a funded capacity of approximately 430,000 kilograms of cannabis per year.
  • Earlier in 2018, the company entered into a strategic investment in The Green Organic Dutchman Holdings Ltd (TGOD), which gives ACB the right to purchase 23,000 kilograms per annum of TGOD’s annual production of organic cannabis.

3. Expansion Into International Markets: ACB has entered into agreements to supply medical cannabis to Germany, Italy, and Australia. Furthermore, through its 51% stake in Aurora Nordic, the company will have a capacity to supply 8,000 kg per annum of cannabis to international markets, particularly those in Scandinavia and Denmark, once the construction of the facility is completed.

4. Supply Agreements: ACB has entered into a number of supply agreements, as well as into a letter of intent to become the preferred supplier. In April 2018, the Company completed an agreement with the Société des Alcools du Québec (SAQ) to supply a minimum of 5,000 kilograms of cannabis for the first year for the Québec adult consumer market, once legalized. In April 2018, Aurora, through its recently acquired subsidiary, CanniMed, entered into a Letter of Intent to become a preferred supplier of medical cannabis to Pharmasave, a cooperative of more than 650 independently-owned community pharmacies.

As a result of the above factors, and consequently a growth in the revenue metrics, we expect the sales to increase to roughly CAD 62 million in FY 2018.

 

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