The cannabis sector has taken a beating in the last few months as sector sales and regulatory issues have taken out some of the hot air in the bubble. The July sales and inventory data from Canada finally provides some positive data points for investors, but the market still faces supply rationalization issues not adequately addressed in the recent Aurora Cannabis (ACB) corporate update. The stock has made an initial bounce off the recent lows below $4, but the investment thesis is still tilted towards a bearish view until the cannabis sector addresses these supply issues.
Image Source: Aurora Cannabis website
Positive Market Data With A Catch
Every month, Health Canada reports monthly cannabis sales and inventory data for dried cannabis and cannabis oil. The past data has shown an industry with surging supply and mostly flat sales growth. The July data finally showed some strong live in the market, but the inventory data remains a massive concern.
The biggest positive was total sales of dried cannabis grew 14% in July to 11,387 kg from 9,976 kg in June. The sequential increase of over 1,400 kg sold in the month was the biggest monthly increase since reporting began back in October with the legalization of recreational cannabis sales.
The major catches are the surging inventory levels and the flat medical cannabis sales. The total inventory of dried cannabis surged to 347,171 kg at the end of July for an inventory level equal to 30.5 times total sales for the month.
The problem here remains that sales grew a strong 1,400 kg sequentially while inventories grew by over 35,000 kg. Supply growth remains far in excess of any rationale demand growth.
The positive for the market is that legal demand is indeed growing as new stores are opened. What isn’t positive for investors is the constant news that retail and online stores are constantly out of product while the market hasn’t even absorbed the unfinished inventory levels from the all the way back in October, not to mention recent levels back in April when companies could’ve easily converted the unfinished inventory into product on shelves.
The potential problem is the industry having a very difficult time matching specific products with demand. A possible sign that the industry has far too many options to maximize profits when traditional consumer packed goods industries that generate large profits had minimal options in the beginning. The beverage industry reached a global scale and billions in annual profits based on only a few main options available to consumers.
Cowen analyst Vivien Azer and her group viewed 1,485 products with 3,032 SKUs from online stores and found the stockout rate increased to 59%. The issue is unlikely to impact industry sales as consumers move onto their next option, but it could easily hurt sales, margins, and brand recognition.
The other catch is that all of the sales increase is going towards recreational cannabis sales, and the more valuable medical cannabis sales are losing out. Canadian medical cannabis sales peaked back in April at over 2,100 kg.
Source: Health Canada stats
Wholesale Bulk Sales
For a collection of these reasons, Aurora Cannabis felt compelled to dump C$20.1 million in the wholesale bulk cannabis market. The amount was C$18.0 million above the level from the March quarter and accounted for 50% of sequential revenue increase in the cannabis sales portion of their quarter that amounted to C$94.6 million.
The company promoted the high 61% margin from these sales, but investors also need to keep in mind the actual gross profit created from cannabis sold at C$3.61 per gram versus the medical cannabis prices still at the C$8.51 level. Even at the slightly lower gross margin, the medical cannabis product would generate C$28.4 million in gross profit or C$16.1 million above the amount generated by wholesale bulk sales.
Source: Aurora Cannabis FQ4’19 MD&A
The whole problem with spending C$414.3 million on Capex last year and C$72.9 million in operating expenses last quarter is that the scale of the business wasn’t built for wholesale bulk sales regardless of the gross margin. Ultimately, the amount of gross profits matters far more. In addition, one has to realize the pot sold into the wholesale market came back onto the market in competition against Aurora Cannabis branded products.
The key investor takeaway is that improving cannabis sales data can’t overcome the large supplies hitting the market. Aurora Cannabis shouldn’t be worth $4.5 billion, if the company is going to dump supply on the market at low gross profits. The stock made an interesting higher low today around $4, but my view doesn’t see improvements in the industry until the company starts restricting production growth.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
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