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Investing, Stocks  | February 4, 2019

Aurora Cannabis (ACB) has been rapidly scaling production over the last several months, as it has gone from 70 kilograms per year, to an projected 150 kilograms per year before the first half of 2019 is over.

And as management stated in its latest earnings report, it is poised to boost production to about 500 kilograms per year in early 2020. That's only a short year from now.

Depending on which baseline above you want to use, Aurora will be boosting kilogram production levels by at least over 3x within a year. If you choose the November 2018 number of 70 kilograms, it'll be up over 7x by the first quarter of 2020.

Further out it has the potential to increase that, with its current holdings, by an additional 200 to 300 kilograms.

Considering the Potential

Just on the revenue side of the business this points to some very high levels of growth over the next couple of years. Bear in mind reaching the 500 kilogram level per year doesn't mean it'll immediately have a major impact on the company; it'll have to sell it over the course of the year to enjoy the full benefit. The point is it'll reach that run rate in early 2020.

Also, since cannabis isn't a seasonal business, using that run rate should be a reliable metric in analyzing future performance. The obvious caveat is whether or not the company achieves its guided numbers. I see nothing at this time that would suggest it won't be able to reach 500 kilograms in annual production within a year or so.

Another element to take into consideration is it'll be hard to know at time what the average selling price per gram will be because they are much different in various markets.

For example, Germany tends to command a higher price per gram, while other markets generate lower prices. In the Latin American market we have yet to see where prices will end up on average.

The good news in my view is demand is exceeding supply at this time, and that should result in a higher floor and ceiling on prices. I don't see that changing this year, and as more countries legalize medical and recreational pot, it'll create more demand for at least several years in my opinion.

There is also the fact more infrastructure must be developed in many markets, which means demand will grow for a long period of time at a measured rate in new markets. That gives Aurora Cannabis time to prepare for the deluge of demand coming its way.

On the timing side, investors need to know there are also cultivation and harvest schedules to consider, meaning supply has to be taken in account for the whole year, not being available at any one time. That's why even though there was annual production capacity of 100,000 kilograms at the end of 2018, the company will end up with 25,000 kilograms available for sale by the end of June 30,2019. It will level up of course, reaching that level on a quarterly basis and higher, as it reaches the 150,000 kilogram rate in a short time from now.

In other words, the second half of the year will be weighted higher than the first half. That will be how it will play out each time it boosts production capacity. It will happen that way when it reaches 500,000 kilograms in production capacity about a year from now. I'm mentioning this so you don't get trigger happy and sell if the market doesn't take into consideration the weighting aspect of product being available for sale on a delayed basis.

Lastly, with Aurora taking the market lead in supply, many customers at the individual and institutional level will be looking for partners that can predictably, consistently and sustainably provide product for them. Aurora has the resources where I think they will be the first company of choice for many customers.

Profitability Coming

In a recent press release CEO Terry Booth said this:

Our consistent and high-quality production continues to significantly ramp up as expected, fueling even further growth. Going forward, we see sustained strong demand from the adult usage market, as evidenced by public statements from the Canadian provinces, as well as strong patient-driven demand for medical cannabis in Canada and abroad. These factors, together with our focus on disciplined management of operating expenses, and our growing portfolio of higher margin products, put us in a position to rapidly achieve positive EBITDA within the next two quarters.

So far the company has driven down costs per gram while introducing and expanding its product line that deliver wider margins. This is a major reason for it being able to confidently guide for profitability within a couple of quarters. That has surprised most in the market, and it's only going to get better.

In Canada, regulations are being drafted and are expected to be finalized concerning additional delivery systems like edibles, beverages and vape pens, which are also higher-margin products. This will further strengthen the profitability of the company at a time when its production capacity is soaring.

This is important because I believe Aurora Cannabis is going to soar in value and share price with or without profitability over the next couple of years, because of its revenue performance. If the company is able to add profitability to that, it's going to perform even better.

Conclusion

One of the major reasons I don't see any significant surprises on the downside is because of the major catalyst behind the rise of the global cannabis industry: taxes.

The demand for recreational and medical pot has been around for years, the reason the industry is exploding in growth is because governments want a piece of the action by taxing legal and regulated pot. Unless you think governments are going to stop looking for tax revenue in new places, it's obvious there is nothing that is going to stop the growth momentum of this sector, other than it reaching a demand ceiling, which is a long way off.

That doesn't guarantee Aurora's performance, but it does guarantee there will be accelerated growth in the global cannabis sector for many years. It also is as close as you can get to safety on the overall market side of the equation. Governments aren't going to undermine the tax potential of the pot industry. There are times when they may slow it down some in the near term, but they aren't going to cut tax revenue streams in any way.

One thing I'm thinking on the slowing down side of the business is when Ontario decided it didn't want giant cannabis companies dominating the market, so it created some bureaucratic barriers companies have to work around before being allowed to compete in Ontario. That slowed down the potential in the short term for some companies, but it's only temporary.

As for Aurora Cannabis, the timing of its growing production capacity and profitability, along with soaring market demand for cannabis, positions it to be the market leader in revenue as the company stands today, with the potential to boost capacity much higher with its existing holdings.

For those reasons, over the next couple of years I see Aurora Cannabis enjoying strong growth, and believe the market is going to reward it and shareholders in a big way.

After that, its growth rate will be determined by what happens during that time in regard to legalization of recreational and medical pot in different markets. Hemp could be a tertiary revenue stream, but I think it's going to take time to see if the optimism with that market is overstated, or it has the potential to attract new customers. I don't include hemp sales in my outlook for the company at this time, but if hemp is able to increase demand at the global level, it could provide a surprise for Aurora and other companies.

Over the next couple of years I see Aurora enjoying the best performance it may ever achieve as far as growth in value at an accelerated pace. Shareholders will probably get the best returns during that time based upon percentage of growth, and I would recommend continuing to take a position in the company at these prices. Finally, don't panic or be tempted to sell if there are volatile swings in prices. I don't think anything can stop Aurora from enjoy a couple of big years. Hang on and enjoy the ride.


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