8 Nov
by Vitaliy Dadalyan
The latest Health Canada stats continue to show the Canadian cannabis market is flooded with supply while most companies are set to further ramp up production capacity and output. Aurora Cannabis (ACB) has long promoted a leadership position in building production capacity despite the expected limitations to the market demand in Canada and around the world. With the stock below $4, investors will want to see the company lead the market in constraining supplies in order to focus on positive cash flows.Soaring Inventories In the latest data for August, Health Canada reported that inventories of dried cannabis continue to soar. The total inventory for the month reached nearly 390,000 kg while sales were only slightly below 13,000 kg.The total inventory of dried cannabis held by cultivators, processors, distributors and retailers in Canada equals over 30 months of sales based on August numbers alone. While some of the supply is being held back for edible and beverage products hitting the market in mid-December, the market is still adding 4-5x the supply as existing demand with further ramp ups expected over the next year.Enough to Supply the Whole MarketAurora Cannabis has forecast reaching production capacity totals approaching 700,000 kg by mid-2020. The company only produced 29,034 kg in the June quarter. The forecast is for production to quickly reach 37,500 kg in the past quarter before the ultimate leap towards 175,000 kg per quarter.The unanswered question is where Aurora Cannabis is going to sell nearly 150,000 kg of new supply when Canadian inventories are already soaring as sales momentum remains slow. The Parliamentary Budget Office only predicted total Canadian cannabis demand in the 700,000 kg range for 2021. In essence, Aurora Cannabis is on a path to supply the whole Canadian market.The company will argue the global opportunity, but other companies like Flowr (FLWR) are building massive supplies including a 500,000 kg operation in Portugal for the European market. The issue is that global rationalization of cannabis supplies needs to occur before the stock will rally.Aurora Cannabis had a C$11.7 million EBITDA loss in FQ4. The market will want to see less discussion on capacity doubling and tripling and more discussion on turning EBITDA profitable with steady supply growth as the legal market demand expands.The company has the additional problem of needing to weed out the illegal competition via lower prices while trying to make a profit by selling pot at higher prices. Ultimately, the lack of physical retail stores over the next few years should compel Aurora Cannabis to pullback on flooding the market with every possibly gram of cannabis.Wall Street VerdictWall Street isn’t sounding the alarms — but isn’t jumping for joy, either. TipRanks analysis of 13 analyst ratings shows a consensus Hold rating, with four analysts suggesting Buy, six saying Hold and three recommending Sell. The average price target among these analysts stands at $5.37, which represents about 40% increase from where the stock is trading today. (See ACB stock analysis)TakeawayThe key investor takeaway is that Aurora Cannabis needs to lead the market on supply rationalization. Otherwise, the company needs to provide a detailed documentation of how the market is going to absorb all the supply reaching the market in the next year while Canadian distributors and processors already hold far too much supply for current sales rates. The stock is stuck below $4 until the market becomes comfortable with supply rationalization in the cannabis sector.To find good ideas for cannabis stocks trading at fair value or better, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.
