Aleafia Health Inc. (ALEAF)

[FUNMAN]

Aurora Cannabis Needs Industry Help

Aleafia made the list of top 10 growers.

Nov. 27, 2019
6:28 AM ET

Read the article here to see the charts.

https://seekingalpha.com/article/4309392-aurora-cannabis-needs-industry-help


Summary

* The Canadian cannabis industry forecasts cutting cultivation capacity by up to 800,000 kg, but the top 10 producers are still expanding existing production.

* Aurora Cannabis still expects to more than double production from FQ1 levels while the top 10 producers are still on path to swamp legal demand.

* Revenue estimates are getting to levels where the company would need to see further material price cuts to not exceed targets.

* The stock price target is $2 without further Canadian cannabis industry rationalization.

The major problems facing Aurora Cannabis (ACB) is that too much of the Canadian cannabis industry hasn't followed their moves with cutting cultivation capacity for 2020 and beyond. A few companies had already cut production targets for various reasons, but the bigger players in the industry still appear full speed ahead with expansion while the industry is already over supplied. For this reason, my investment thesis thinks Aurora Cannabis made smart decisions to cut production in half, but the stock isn't a buy even with the dip towards $2. A few altered production plans from top competitors could quickly change this view.

Limited Production Cuts
The monthly Health Canada industry inventory reports were crying for the top cannabis producers to cut forecasted output. The kg sold on a sequential monthly basis were growing by a few thousand kg at most, yet total inventories were soaring by up to 50,000 kg per month.

Even worse, the industry was still forecast to further expand output by a substantial amount. The top 10 producers alone were scheduled to top 2.5 million kg in annual output with the potential of reaching 3.0 million kg on Zenabis Global (OTCPK:ZBISF) reaching full production targets of nearly 500,000 kg.

In the course of a few months, CannTrust (CTST) was shut down by regulators at least temporarily cutting off up to 300,000 kg in annual production. The move was followed by HEXO (HEXO) removing 70,000 kg from production to reduce their targeted goal to 80,000 kg annually. In addition, The Green Organic Dutchman (OTCQX:TGODF) slashed production from a target of 219,000 kg to only 20,000 kg.

When combined with the decision of Aurora Cannabis to not complete two existing factories with shells in place and Zenabis Global pulling back on massive goals to jump production up to 490,800 kg, the market might incorrectly derive a view that Canadian cannabis companies are pulling production inline with demand. The forecasted top 10 producers are now scheduled with these annual production targets of ~1.8 million kg:

1) Aurora Cannabis - 350,000 kg*

2) Canopy Growth (OTC:CGC) - 550,000 kg

3) Aphria (OTC:APHA) - 255,000 kg

4) CannTrust - 0 kg*

5) The Green Organic Dutchman (OTCQX:TGODF) - 22,000* kg (down from 219,000 kg)

6) HEXO - 80,000 kg* (down from 150,000 kg)

7) Aleafia Health (OTCQX:ALEAF) - 129,500 kg

8) Zenabis Global (OTCPK:ZBISF) - 143,200 kg (up from 131,300 kg)

9) Cronos Group (OTC:CRON) - 117,500 kg

10) OrganiGram Holdings (OTC:OGI) - 113,000 kg

*Decreased plans for 2020 production.

The reality is that these cannabis producers are only cutting future capacity growth. CannTrust was the only company to cut actual production, but this was due to audit problems and the amounts might return to the market.

Aurora Cannabis and The Green Organic Dutchman are the only companies to remove a material amount of production targets from corporate plans. HEXO only stripped out 70,000 kg while CannTrust hopes to return to production in 2020 after meeting all of the remediation requirements in the plan submitted to Health Canada. Also, the Zenabis Global production forecast is actually up from the original plan as the company achieved more production with existing faculties and only chose to pullback on product never included in the forecasts.

The top 10 producers are still planning on producing ~1.8 million kg of cannabis while the long-term market demand in Canada has always been proposed at around 900,000 kg. According to Cannabis Benchmarks, the Canadian market sales over the last year was only C$1.1 billion on sales of an estimated 105,000 kg. In essence, the top 10 producers are still on schedule to flood the market with supply despite cutting production targets by ~800,000 kg.

The other troubling part is that CannTrust could easily restart operations and commence plans to flood the market with another 200,000 kg in 2020. The Green Organic Dutchman has ready plans to recommence completion of the Valleyfield facility in two phases that will add 65,000 kg each to add another 130,000 kg of production.

Aurora Cannabis has to recommit to spending C$190 million on completing their two facilities. The company needs to spend at ~C$110 million in order to finish the Aurora Sun facility in Canada to fully maximize the planned 238,000 kg output from that facility or ~200,000 additional kg.

Impact

Analysts have already substantially cut the forward revenue estimates for Aurora Cannabis. The FY21 targets are down below $600 million, but the low analyst target is a meager $300 million. On average, the yearly estimates through FY22 (ends June) are down 50% from the peak levels around mid year.

For the stock to become a buy, the sector needs to commit to more capacity growth cuts. Both Canopy Growth and Aphria need to refrain from plans to reach max capacity levels that combined will top the demands in the Canadian market and far exceed existing demand.

In addition, the retail store issue needs to be resolved along with a successful launch of Cannabis 2.0 before the stock becomes a buy. With rational supply, analysts are only forecasting the kg equivalent of $2.71 per gram based on FY20 revenues of $950 million and supply still reaching 350,000 kg. More reasonable prices could double the revenue estimates, but too much industry supply isn't going to allow reasonable prices and possibly Aurora Cannabis won't even find a market for the currently planned production.

Takeaway

The key investor takeaway is that the cannabis industry has made substantial cuts to planned cultivation facilities in 2020, but the top 10 producers still expect to substantial expand current production levels. In addition, the planned production capacity of these producers is expected to double total demand in Canada and far swamp existing legal consumption.

For these reasons, Aurora Cannabis has made smart decisions to lower production goals, but the industry still hasn't fully rationalized supply to meet actual demand. Investors should fade the recent rally and look to buy the stock if it holds $2 where the stock hits a $2.4 billion market cap.