Canopy Growth Corp (WEED)

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Canopy And Aurora: Who Just Had The Better Quarter?

Feb. 23, 2018 9:48 AM ET|13 comments| About: Aurora Cannabis Inc. (ACBFF), TWMJF, Includes: CMMDF, LQSIF, VRNDF
Cornerstone Investments
Cornerstone Investments
Long only, special situations, medium-term horizon

(4,281 followers)
Summary

Canopy announced lower cash cost, higher production, and strong build in inventory which supported its recent supply deal wins.

Aurora remains a show-me story with significant execution risk.

Canopy so far has executed better in preparation for the upcoming legalization but Aurora has potential to catch in B.C. and Alberta.

The rivalry between Canopy (OTCPK:TWMJF) and Aurora (OTCQX:ACBFF) has only intensified in recent months as Aurora is set to surpass Canopy as the largest cannabis company in the world after announcing its acquisition of CanniMed (OTC:CMMDF). We have written in "Is Canopy Falling Behind Aurora?" that we think Canopy has been focusing on perfecting execution and preparing for the upcoming legalization while Aurora has embarked on an acquisition spree that saw its investments spanning from greenhouse contractor to liquor stores. Both companies have reported their latest quarter, and we think it is time to have a comparison of who had the better quarter!



Canopy Highlights

Canopy reported Q3 F2018 results that saw several positive developments. The patient counts increased 138% to 69k, another 10% increase on a sequential basis. Canopy boasts the largest active registered patients' base in the market and also the largest current production. Canopy achieved a significant reduction in production costs and saw its cost per gram dropping to $1.03 per gram in the quarter. Canopy harvested almost 8 million kilograms while sales were 2.3 million kilograms. Revenue came in at $21.7 million, up 23% sequentially and 123% year over year. The average selling price was $8.30 per gram, a 13% increase from last year. Lastly, Canopy had $238 million of cash on hands at the end of the quarter, before accounting for the net proceeds of $192.5 million from recently completed bought deal financing.



(Canopy Financial Statements)

Aurora Highlights

Aurora also reported a strong quarter. Revenue increased by 42% to $11.7 million sequentially. Actively registered patient count grew 12.6% to almost 22k. Total grams sold increased 31% sequentially to 1.1 million grams and represent 116% increase from last year. Grams produced was close to the grams sold at 1.2 million gram. Average selling price increased to $8.36 representing a 1.7% increase sequentially and 40% increase over last year. Cash cost per gram decreased by 25% sequentially to $1.41. At the end of the quarter, Aurora held cash balance of $350 million, before investment of Liquor Stores (OTCPK:LQSIF) and CanniMed acquisition (cash portion of the consideration to be determined).



(Aurora Financial Statements)

Comparison #1 Production Costs

As we discussed at length in The Complete Cannabis Guide #1: Production Cost that production costs will become a key competitive advantage for producers once legalization happens. The influx of LPs and numerous expansions announced by existing producers will most likely result in the market oversupplied. In an oversupplied market, prices will be pressured and only producers on the low end of the cost curve will be able to survive. Canopy has already established the largest scale in the industry and is moving down the cost curve at a fast pace. Canopy's cost per gram before fulfilling dropped 18% in the latest quarter from $1.25 to $1.03, approaching some of the lowest costs we have seen in the industry. Aurora, in the meantime, dropped from $1.87 to $1.41, still much higher than the industry averages. Canopy is clearly winning in this metric at the moment. We acknowledge that Aurora Sky is supposed to deliver some of the best cash costs for Aurora in the coming quarters, but execution risks remain a valid concern given its lack of track record in large-scale production.



(Tutor2U)

Comparison #2 Production and Inventory

Canopy has absolutely blown us away this quarter with its production and inventory build up. As we have reiterated in our "5 Predictions For The Cannabis Industry", we think the key thing to watch for 2018 is the supply agreements. One of the key requirement for supply agreements is a company's ability to deliver high-quality cannabis with reliability. The Canadian Senate has announced that cannabis legalization won't happen before August 2018, leaving at least three more quarters for companies to fill up inventory in preparation for a consumer frenzy in the initial few months.

This past quarter, Canopy increased its production by 91% to almost 8 million grams. With sales of 2.3 million grams, Canopy was able to build up inventory significantly and will continue to do so in the coming quarters. Canopy reported inventory and biological assets valued at a record $108 million by the end of the quarter. Aurora showed a very different picture as production barely covered sales, which means little to none has been saved for inventory. Aurora has also reported a smaller inventory of $17 million, basically unchanged from last quarter.

Usually, an inventory build could be a result of bad working capital management or falling sales. In this case, as the cannabis industry is ripe for legalization later this year, there will be an initial surge in demand as consumers chase novelty. We expect the industry to be undersupplied initially as many producers are still in the process of constructing their facilities, not to mention start producing cannabis and building up an inventory. We like Canopy's large inventory position because it will be crucial for the company to win provincial deals. For companies that do not have any inventory in hand, it would be tough to convince provinces that they could become a reliable supplier in the near-term, as there are risks inherent in cultivation and harvesting. In the case of Aurora, the company's production is only enough to satisfy its current sales, which means that there won't be any room for the recreational market when it becomes legalized. The difference between the cannabis industry and others is that a much bigger market will open up this year and demand will increase multifold, placing a big emphasis on producers to ramp up production and have inventory on hand to stock the shelves.



(legalcannabis.com)

Comparison #3 Provincial Deals

Another point we want to bring up is the results from recently announced Quebec and Manitoba deals. In the Quebec deal, as we recently wrote in "Canopy Clinched Quebec Victory" that Canopy has secured a larger deal of 12,000 kg annually versus Aurora's 5,000 kg annually. We don't blindly take the headline number as little details were provided by the six companies that secured a deal and actual sales numbers could vary depending on final delivery. There was also little details regarding the terms of the deals. However, last week, Canopy also announced that its partnership with Delta 9 (OTC:VRNDF) was selected as one of the four groups to operate retail licenses for the provincial cannabis sales. Aurora was nowhere to be found in the deal. It is worth noting that Aphria (OTCQB:APHQF) also secured one of the retail licenses through its investment in Hiku/Tokyo Smoke, another group that was selected. If you add Canopy's previously announced supply deal with New Brunswick, Newfoundland and Labrador, and Prince Edward Island it becomes clear that Aurora is quickly falling behind Canopy as its limited scale is hurting its execution.

If you look at the map below, the only large provinces that have yet to announce a supply deal are Ontario, British Columbia, and Alberta. We think Canopy is better positioned in Ontario due to its dominant position in the province. Canopy is also building out its British Columbia through its 67% owned joint venture, BC Tweed. Canopy has already started expanding crazily in B.C. as it was reported that its 1.3 million sq. ft. Langley facility will start harvesting in Spring 2018, with a second facility planned in Delta, B.C. for later this year. Aurora is building its largest Aurora Sky facility in Edmonton, Alberta and is in the process of acquiring CanniMed which is based in Saskatchewan. Aurora also announced its investment in Liquor Stores and we have written about the deal in details in "Why Aurora Cannabis Invested Into Liquor Stores" where we concluded that Aurora is indeed doubling down on the Alberta market. Alberta has the fourth largest population after Ontario, Quebec, and British Columbia but by itself alone cannot support Aurora's current market capitalization. Aurora needs to score big in the upcoming supply agreements, especially Ontario and British Columbia.

https://static.seekingalpha.com/uploads/2018/1/20/24621363-1516430235035653.png

(Government of Canada)

Summary

As we wrote in our recent article "Is Canopy Falling Behind Aurora?", we think the execution risk of Aurora remains high as it lacks the scale to secure the first wave of supply agreements and its future growth hinges on the timely and flawless delivery of Aurora Sky. We have long been praising the focus and execution of Canopy management, and they have delivered another promising quarter with rising inventory, lower cash cost, and increasing cannabis productions. Aurora also had a good quarter with rising sales, higher patient counts, and a good update on its upcoming facilities and international expansions. However, we would like to see Aurora focus more on the domestic recreational market as it will become the single largest and most important market for all cannabis companies. International markets represent long-term opportunities but near-term contribution will remain limited and these countries could be years away from legalizing recreational cannabis.

Additional Resources

We publish on cannabis-related topics regularly. Consider "follow us" to stay informed of the latest development and best ideas in the sector. We also publish a widely read Weekly Cannabis Report which is your best way to receive our weekly review and analysis of the cannabis sector.

You can also find our previous articles on the cannabis industry:

Is Canopy Falling Behind Aurora?
Best Way To Play The Cannabis Industry
5 Predictions For the Cannabis Industry
The Complete Cannabis Guide #1 - Production Cost
The Complete Cannabis Guide #2 - Production Capacity
The Complete Cannabis Guide #3 - Consumption
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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