Last week the press was alive with the rumours that Coca-Cola was going to join forces with Aurora Cannabis to produce a line of non-psycho active CDB wellness drinks. This week Aurora released their 2018 Q4 performance update and the results were very impressive.

Let’s dive a little deeper into the workings of the world’s second largest cannabis company.

Cultivation

Aurora is a cultivation powerhouse. With a total funded capacity of 570,000kg per year, they are well set to take advantage of the booming global marijuana market. To put this in perspective, the current estimated Canadian demand for both recreational and medicinal marijuana, is around 800,000kg per annum.

The company has forecast that by the end of 2018, it will deliver a production rate north of 150,000kg and expects that Aurora Sky should reach full cultivation capacity (of 100,000kg per annum) by the end of this calendar year.

By the end of the calendar year 2019, they will be producing at optimum levels of capacity and will be supplying both their native Canadian market, as well as many of the global markets.

The above chart is an overview of their current (fully funded) facilities both completed and under development. The words “fully funded” are very important, as a lot of companies talk about what their ultimate capacity will be, but are still looking to actually fund that capacity.

The biggest, and most crucial, near-term facility is Aurora Sky. Based next to the Edmington airport in Canada (hence the name), it is the facility that will define execution for Aurora. The facility – the most technically advanced in the world – will be instrumental in delivering the forward revenue they are projecting.

Being their most important asset also creates a binary risk. Make no mistake, should this facility produce the yield they are suggesting, then the stock price will deliver tremendous value for shareholders in 2019. However, if for any reason it does not, then there could be a significant downside to their share price. 

Aurora Sky is due to deliver 100,000kg of flower per annum, and as a result of the world-class technology, they should be able to produce these kinds of quantities for less than $1 per gram.  It is important to note that this facility alone will produce nearly 20% of Aurora’s total funded capacity. They have just finished their second harvest cycle and are now awaiting their sales permit for the facility. This is one area of the business investors should pay very close attention to.

One of the keys to their success was their purchase of Larson Projects (now Aurora Larsen Projects – ALPS) who are recognised as industry leaders in the design, development, and construction of greenhouse (both stand-alone and hybrid) facilities. ALPS is currently developing facilities in Canada, Denmark, and Australia. This was an extremely smart move on their part, as access to best-in-class facility production ensures that they greenhouses are supremely efficient.

Global Coverage

Aurora Cannabis have extensive global coverage with sales and operational facilities in 14 countries and across 5 continents. They have 9 facilities in Canada alone and have secured purchase orders with all 11 provinces (covering over 89% of the Canadian population) to supply the recreational market come 17 October.

They are also betting big on the European market. In Germany, considered to be the biggest EU market for both medicinal and (eventually) recreational marijuana, they have extensive coverage through the largest network of pharmacies (ensuring full margin is maintained) and have achieved this through their purchase of Pedianos.

Although Pedianos will predominantly supply the German market, it also has supply agreements with Italy, Portugal, and Denmark. Even though Aurora recently announced they were scaling back the production of oils and flower for the EU (to secure supply for recreational legalisation in Canada), they still increased their supply to the EU and are market-leading in terms of revenue numbers across Europe.

In Australia, they have a 22% stake in the largest Medicinal Marijuana Company – the Cann Group. The first company in Australia to be awarded all 3 licenses (cultivation, manufacture, and R&D) by the Australian government, they are well placed to take advantage of what will be a significant market both in terms of supply (estimated to be worth $2bn a year) and as a launch pad into Asia.

Medicinal Marijuana

In the medicinal market, pharmaceutical IP is the key to long-term differentiation. Aurora has recognised this and through very strategic acquisitions are well placed to develop long-term commercial opportunities.

With their strategic relationship with Israeli-based Tikun Olum, they have tapped into one of the oldest and most experienced laboratories. Having studied the cannabis plant for over 20 years, Tikun Olum has the most extensive data on the effects of various Cannabinoids on patients covering a range of ailments.

Their purchase of Anandia Labs this year gave them exclusive access to best-in-class genetics, testing laboratories, and breeding. Genetics – and in particular testing – is going to be vital in creating points of difference in a market where cannabis will eventually be produced in such large quantities, as to be treated as a commodity.

But it doesn’t stop there. Over the past 18 months, Aurora has been on a shopping spree and now have medicinal coverage in 9 countries.

The Acquisition Kings

No one has been more active in the acquisition market than Aurora. Having closed two of the largest acquisitions in the industry, they have followed that up with a string of purchases that have created one of the most robust, vertically-integrated companies, on the planet.

Their January 2018 purchase of CanniMed for $1.1bn (which was hostile in its nature) created immediate scale in the number of medical patients, and they followed that up with their $2.5bn acquisition of MedReleaf in August of this year.

This gave them scale in both production and product range, particularly in Ontario (the largest province by population, and subsequently the largest market for both medicinal and recreational marijuana). MedReleaf is also the market leader in the production of medicinal oils and were the first to bring both topical creams and softgel capsules to market.

Through acquisitions, they have created a management team rich in experience and track record. CEO, Terry Booth, founded Aurora in 2013 when Health Canada announced the creation of the new MMPR program. Investing $2.5 million of his own capital in start-up funding Terry secured a 100-acre parcel of land and began designing and building Aurora’s first state of the art marijuana cultivation facility in Canada.

To date, he has served as President/CEO of 6 other highly successful companies including one that was awarded one of Canada’s top 50 fastest growing companies. Terry oversees the corporate strategy of the company including operations, sales, patient acquisition, doctor education programs, genetics development, regulatory affairs, facility expansion as well as the daily requirements of communicating with local and foreign capital markets and investors.

There are Risks

There is a lot to admire about Aurora and they have many, many positives. However, only a fool would ignore the risks. One of the biggest risks facing the company is integration. With so many purchases, the risk of execution becomes exponentially greater with each company added to the Aurora family.

The team have acknowledged this though and have created a special division just to manage the internal integration of staff and culture throughout the organisation. They brought in Andre Jerome as Senior VP of Business Integration.  Jerome oversaw the global integration of Vodafone as it aggressively expanded its reach in the in the mid to late 2000’s.

Another issue with all the purchases is that of shareholder dilution. Most of Aurora’s deals have been financed through the issuance of additional stock. Whilst in the short term this makes financial sense in terms of the having significant cash-flow to fund operations, the exponential increase in the number of shares could have a negative impact on EPS in the coming years as the company grows into its current valuation.

And finally, one cannot talk about risks without mentioning execution risk. The company is betting the house on Aurora Sky and its ability to produce enough cannabis to take advantage of the coming wave of demand as recreational legalisation looms. The company states that all is on track for full-scale production from mid-2019, but investors should be aware of this “binary outcome”. Should Aurora deliver, then expect a solid upward move in the share price. The same, unfortunately, would apply should they not.

The Stock

Aurora’s stock has been under pressure since the turn of the year. It has seriously lagged its peers in performance. There are a couple of reasons for this. First off, as mentioned, the majority of their deals were done for stock and not cash. A lot of the shareholders of the companies being acquired may not have wanted to own Aurora, and hence once the deals were completed, there were the inevitable sell-offs. This played out in both the CanniMed and MedReleaf transactions.

Secondly, it comes down to the execution risk. Investors are nervous that the forward revenue projections baked into the current share price may not materialise should Aurora Sky not deliver the mother load. The time of “what could be” will end on October 17th, and with it, the time of “show and tell” will begin. Aurora has doubled down on Aurora Sky, and the time to deliver looms large.

Q4 2018 Financials

Aurora recently released their 2018 Q4 results. Revenue of $19.1m for the quarter (an increase of 233% on their 2017 Q4 revenue) was below analysts expectations of $23m. Although to be fair, it did not include the consolidation of MedReleaf’s revenue as the deal was only finalised in late August.

Including Medreleaf’s revenue of $14.9m would boost Pro-forma revenues to $33m. This is the highest quarterly run rate of any of the big 5 Canadian Licensed Producers (including Canopy Growth and Aphria).

Effectively, Aurora Cannabis tripled their revenues in Q4. The company brought in a net income of $79.3 million, compared to a net loss of $20.8 million in Q3

Patient count increased to just over 43,000, up 164% on 2017 Q4 and Gross Margin was up 28% from 2017 Q4. This was as result of a higher average selling price ($9.20 per gram) and an increase in the proportion of oil sales relative to overall revenue (26% oils v 74% flower).

International sales were also extremely robust with 21% of their revenue coming as a result of their strategic partnerships in the EU. On the recent management call to review the results, they also indicated they were ready for the recreational demand, come October 17, with internal inventory stockpiles and off-take agreements from many of their partners and suppliers, ready.

Bottom Line

Following the mega-deal between Constellation Brands and Canopy Growth, there is no doubt that the world’s second largest cannabis company must do a deal to keep pace. Rumours of a deal with Coca-Cola sent the market (and it’s share price) into a frenzy.

Whether this pans out to be true remains to be seen, and should it be true, there is a significant upside to the share price.  Not only Coca-Cola, but Diego too have been rumoured to be considering an investment.

Aurora announced this week their intention to list on one of the two major US exchanges. Although I am not sure if it will be the NYSE or the Nasdaq, one thing’s for sure, if they do, expect an increase in the share price as US retail investors continue to pile into the market. This has been seen by the hyperbolic share price growth of Canopy Growth, Tilray, and Cronos.

Aurora, being the king of acquisitions, would greatly benefit from a US listing. As mentioned above, it would immediately give it better access to capital and should increase the company’s prestige which might make US companies more open to acquisition, and the company itself, more attractive to a major investor or partner.

With significant IP across the entire value chain, the largest revenue run rate in the industry, and it’s expanding global reach, we believe Aurora to have tremendous upside.  We believe them to be one of the best placed to take advantage of the booming, exponentially growing, global marijuana industry.

Are we buying? You bet we are.

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