Aurora Cannabis: Waiting To Enter The U.S. CBD Market
Dec. 13, 2019 3:24 PM ET
Cornerstone Investments
Long/short equity, long-term horizon, cannabis industry
Summary
Aurora was widely expected to enter the U.S. hemp market after the U.S. legalized industrial hemp through the 2018 Farm Bill but no action has been announced so far.
Aurora could leverage its existing Canadian and European hemp assets to launch its U.S. hemp platform or acquire an American player.
The most profitable segment of the hemp industry is health and wellness CBD products instead of other industrial applications.
We expect a move to the U.S. without dilution would be well-received among Aurora investors.
All signs are pointing to Aurora Cannabis (ACB) entering the U.S. hemp industry any moment from now. The company raised US$250 million of convertible senior notes earlier this year and it has told media that it plans to release hemp-based products in 2019 which is looking unlikely at this point. We think the U.S. hemp market represents the biggest near-term growth opportunity for Aurora and a natural extension of its international cannabis platform. Without the U.S. platform, Aurora will always face a competitive disadvantage when competing with global peers with a U.S. footprint including Canopy (OTC:CGC), Cronos (OTC:CRON), and Tilray (TLRY).
(All amounts in C$)
Only a Matter of Time
Aurora told Business Insider earlier in the year that it is looking to get into the U.S. hemp industry and will release hemp-based products in the next few months. In January, the company also announced a US$250 million convertibles raise which we have interpreted as another sign that the company is looking to fund potential U.S. expansion, with hemp being the most likely area. Before the 2018 Farm Bill legalized industrial hemp, Canadian companies were restricted from operating in the U.S. but that has changed forever. The U.S. has essentially opened its doors to Canadian cannabis companies looking to enter a massive growth market.
(Source: Business Insider)
After industry leader Canopy announced and broke ground on its industrial hemp park in New York along with a US$100-$150 million investment, we think Aurora is ready to enter the lucrative U.S. hemp market which will provide significant near-term growth opportunity.
Why The U.S. Hemp Market?
First of all, it is important for readers to understand that the biggest potential market for hemp is the CBD market. As we discussed in "The True Reasons Why Coca-Cola Might Prefer Aurora Cannabis", hemp has many uses for the entire plant including seed to stalk. However, most of the industrial applications of hemp represent the low-margin and low-growth commodity types of business. Companies like Aurora are aspiring to obtain margins similar to the CPG companies where EBITDA margins are often in the 30% range. However, it is impossible to see that kind of margin by focusing on applications such as building materials, paper, textiles, etc.
(Source: Bloomberg)
For Aurora, the hemp-derived CBD markets represent the most attractive industry due to the fat margins and large potential customers. Consumers are willing to pay a premium for CBD markets due to the novel effect and the discovered health and wellness benefits of CBD. We have seen CBD applications in a variety of product forms such as edibles, beverages, oils, topical creams, etc. We think Aurora should focus on the CBD product segment and work to build its brand as consumer recognition and brand loyalty will prove to be the key to success in the American market. Charlotte's Web has enjoyed the benefits of being one of the most widely-recognized CBD brands in America and it takes time to build that level of recognition.
How Will Aurora Compete?
Canopy has chosen to build its U.S. hemp presence through self-funded organic growth but we think Aurora might take a different approach here. For Aurora, arguably the most acquisitive cannabis company in the industry, we think it is not inconceivable for Aurora to acquire an existing player. The most notable hemp players in the U.S. include Charlotte's Web (OTCQX:CWBHF) and CV Sciences (OTCQB:CVSI) but we think they are too big for Aurora to swallow given the dilution concerns among Aurora investors. The ballooning share count and constant dilution have pressured Aurora shares in the past and these companies are large enough to create big dilutions to existing investors. That's why we think Aurora will look into its own asset portfolio to figure out a way to break into the U.S. market.
Aurora owned 53% of Hempco before it acquired the remaining shares earlier this year. We think there is a possibility that Hempco could be used by Aurora as a platform to launch into the U.S. hemp market initially. Our understanding is that hemp products can be imported to the U.S. since it is legalized in Canada. Thus, technically Aurora could use its Hempco resources to develop CBD products and import them to the U.S. for sale. The key would be to establish a network of distributors and marketers to ensure wide coverage of retail outlets initially.
Aurora also owns other hemp assets globally including a large producer and processor in Europe and ICC Labs in Latin America. Radient is also supposed to provide extraction technology to Aurora but we have seen little progress so far. Overall, we think Aurora has the technology and footprint to produce CBD products on a commercial scale. The focus should be on the go-to-market strategy and sales and distribution network.
Looking Ahead
We believe that the future of the U.S. hemp industry lies in the health and wellness applications of hemp-derived CBD products. The other applications of hemp could be additive to hemp producers but we think it is critical for cannabis companies to focus on the growing CBD market. Consumers are just beginning to embrace CBD as a key ingredient in food and personal care production but the market remains in its infancy at the onset of the legalization. We look forward to seeing Aurora's first move into the U.S. hemp market and we believe it is likely to pursue an organic approach or small acquisitions. Cronos joined Canopy after it acquired Redwood Holding, a producer of CBD products, for US$300 million. We think Aurora could pursue a similar approach but its large share count and dilution concerns among investors could force the company to be cautious about M&A. Nevertheless, we believe Aurora will benefit from the growth opportunities that are found in the U.S. CBD market and we expect a positive share price announcement when the company announces its entry into the market. Given the recent headwinds facing the cannabis sector and Aurora specifically, we think a major strategic move like this is required to even have a chance of improving investor sentiment. Lastly, we expect the U.S. CBD market to remain crowded in the near-term but Aurora benefits from its manufacturing experience in Canada and its fledgling global leadership team.
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