Aurora Cannabis (ACB), along with most of its peers in the cannabis sector, have been getting hammered as investor sentiment has, for the most part, soured on the sector.
With global markets taking longer than expected to scale significantly, and Canadian officials dropping the ball on licensing and rolling out retail outlets, it has taken a toll on Aurora and its Canadian competitors.
Since Aurora's prior management team made decisions based upon a much larger base of stores to sell out of, which in turn has allowed the black market cannabis segment to remain stronger than it should have at this point in time, it has put downward pressure on recreational pot prices in particular, which has pushed revenue down and squeezed margins.
That said, Aurora does have some potential short-term catalysts that could surprise the market if they play out the way I describe in this article.
Cannabis 2.0
In its latest earnings report Aurora management gave some positive numbers associated with derivative sales in the current quarter, saying "we think that approximately 20% of our sales will come from 2.0 products..."
What will determine the impact on the performance of the company during this quarter will be the mix of products sold and whether or not they're attracting a significant number of new customers.
That's important to take into consideration because existing customers, even if they transition to higher-priced derivatives, won't generate the amount of revenue or earnings that a totally new customer will, as measured against the previous reporting period. The reason why is if a current customer changes to derivatives, the increase in revenue would come from the previous price being paid by that customer. If it's a new customer, it would represent a much higher result in terms of revenue, margins and earnings.
Assuming the 20 percent guidance is close to being accurate, the percentage of new customers will determine the effect on the performance of the company. If there are a lot of new customers, it should produce more revenue than the market is looking for.
I think it's very possible this could work out this way because of the stigma attached to smoking or vaping cannabis. Having alternative products to consume could attract an entire new customer base. Bear in mind that the company reported C$3 million in derivative sales in a short period of December. The numbers for this quarter will give the first glimpse in the potential of Cannabis 2.0 products on Aurora going forward.
What could make that irrelevant in the near term
The other major part of the performance of Aurora Cannabis in this quarter will be how it does with recreational pot sales. It has been declining recently, and if it isn't able to at least maintain recreational pot revenue at current levels, it would probably offset the bulk of the benefit of derivative sales.
On the other hand, if Aurora is able to at least hold serve on recreational sales in comparison to the prior quarter (not including derivative sales), it would probably surprise the market in a big way.
While I continue to believe long-term, sustainable growth for Aurora will come primarily from medical cannabis, in the near term it is more reliant on recreational sales than it will be in the future.
For that reason if it falters on recreational sales, derivatives, at best, may only allow the company to perform at levels near to what it did in the last quarter. The difference will be its margins and earnings should improve from higher prices.
Sales from Germany will increase
In the last quarter international sales dropped from C$5 million to C$1.8 million sequentially. That came from the company dropping the ball in regard to a permitting issue.
That has been resolved and the company should gain much of what it lost in the last quarter. It's not a huge amount of revenue, but when combined with the potential to outperform on derivatives, it, combined with solid recreational pot sales, would result in the company beating expectations.
Aurora did state that the important German market will continue to grow incrementally, but at a slower pace than anticipated in the past.
Conclusion
It remains to be seen what the impact from coronavirus will be on Aurora Cannabis. Initial industry reports suggested consumers were responding to cannabis in a similar way they were to food and toilet paper, meaning they were stocking up in case of a prolonged period of inability to acquire product.
The issue going forward will be if that is continuing to go on while the virus spreads, or it was more of an one-off event. If consumers are buying cannabis in fear of running out of supply, it could generate the type of revenue that would be a game changer for Aurora in this quarter.
The downside would be if consumers decide to distance themselves and stay away from retail outlets. They could order online, but that hasn't been the preferred way to acquire product in the past, and remains to be seen if that has changed during this quarter. If the things pointed out in this article go right for Aurora, and its able to at least generate as much dry cannabis sales as it did in the prior reporting period, and add an additional 20 percent in sales from derivatives, it will surprise a lot of investors in the next earnings report.
Add to that the increase in international sales, and it would be a strong catalyst that would boost the share price of the company.
Taking into account the company generated C$34 million in recreational sales last quarter, and assuming it at least does the same this quarter, adding more revenue from derivatives (presumably about C$7 million based upon 20 percent guidance), it's easy to see it has the potential to surprise the market.
I understand the C$7 million above could be included in the C$34 million, but my thesis is there's a good chance from the increase in retail outlets and the initial boost in sales coming from fears concerning the lack of product from coronavirus, that the company could come close to matching revenue from the prior quarter without derivative sales.
The caveat as already mentioned, is if people distancing themselves after the big initial buy have stopped buying much product afterwards. Under that scenario Aurora would struggle to maintain its revenue performance from last quarter.
I believe there is better than a 50 percent chance Aurora will surprise to the upside in the quarter, for the reasons outlined in this article. If it does beat, it's going to go on a nice run.
