While MedReleaf has an edge in its production-cost profile, Aurora Cannabis has the advantage with higher production capacity, double-digit growth rate, and international opportunities
SmallCapPower | January 31, 2018: As the recreational legalization of cannabis in Canada fast approaches, there is unprecedented investor interest in cannabis stocks. The initial interest and meaningful growth in the cannabis sector began in August 2016, when the Government of Canada introduced new regulations governing the use of cannabis for medical purposes.
In an attempt to keep their promises from the October 2015 federal election, Canada’s Liberal Party announced in March 2017, that recreational cannabis will be legalized across Canada on, or shortly after, July 1, 2018. This proposed legalization has led to an unprecedented boom in cannabis stocks, as investors seek to pick a winner(s) from this change of legislation. Legalization could open up a large opportunity, with some research firms such as Deloitte forecasting an annual market of $22 billion. Marijuana Business Daily, on the other hand, projects a conservative $2.3 billion annual market in 2018/19, increasing to $4.5 billion by 2021. Once cannabis is fully legalized, it will allow institutional investors to take a bigger stake in the industry. For those who want to invest now, though, before recreational legalization this summer, it is important to stick to the most financially sound companies. If investors stick to companies with healthy balance sheets and fully-permitted licensing already in place, pump and dumps can be easily avoided.
So, in this article we will be comparing two Canadian marijuana producers, Aurora Cannabis Inc. (TSX:ACB) and MedReleaf Corp. (TSX:LEAF), which are financially sound and gearing up for the recreational legalization of the industry in Canada.
Quarter-to-Quarter Revenue Growth:
For these companies, revenue growth is the most significant factor and it is quickly reflected in stock prices as quarterly reports roll out.
MedReleaf posted negative revenue growth in its most recent quarter due to the impact of volume and price restrictions imposed by the VAC policy in November 2016 and May 2017, respectively. Aurora Cannabis, on the other hand, has not been affected by the VAC policy, which shows how well the Company’s management had overcome the regulatory change, posting tremendous growth of 39%.
Production and Supply
Currently, Aurora Cannabis has a production capacity of ~10,000 kgs per year, which will increase to more than 100,000 kgs per year once the mammoth 800,000 sq ft “Aurora Sky” facility comes online by end 2018. Aurora Cannabis has confirmed the acquisition of CanniMed Therapeutics Inc. (TSX:CMED), which will immediately add 7,000 kgs with potential to add another 13,000 kgs by 2019, while MedReleaf will have capacity of just 35,000 kgs by the end of 2018.
With almost four times expected production, Aurora Cannabis wins this metric. Aurora’s substantial capacity will play a big role in capturing the market as, and when, recreational marijuana use becomes legal.
Production Cost/Gram
Cost to produce will significantly define the margin levels, so it is important to compare this metric for the recent quarter. This is a factor that will scale in importance as revenues grow.
Clearly MedReleaf wins in this metric. Due to low production costs, MedReleaf is able to generate profits at the operating level and is one of the few cannabis companies able to produce profits at a very early stage. Aurora Cannabis, meanwhile, is unprofitable at its current operating level.
Valuation
Most Canadian marijuana stocks are trading at inflated valuations due to future expectations and the nascent stage of the industry. Recent valuations are astronomically high given the increased investor activity in the cannabis space as the recreational legalization date in Canada is fast approaching.
In terms of price-to-sales, Aurora Cannabis currently trades at a 400% premium to MedReleaf. This premium can be easily justified given that Aurora Cannabis has better growth prospects, higher production capacity and huge international opportunity.
Recent Developments
Aurora Cannabis: On January 24, 2018, Aurora Cannabis has agreed to buy CanniMed Therapeutics for $1.1 billion. This combination would create the most valuable cannabis company in Canada, surpassing Canopy Growth Corporation (TSX:WEED). As legalization of recreational cannabis in Canada fast approaches, this deal will put Aurora Cannabis in a comfortable position to capture a bigger share of the recreational market.
MedReleaf: Over the last couple of months MedReleaf has secured over $200 million in financing; one for $100.7 million, and the other for $100.5 million in November. Much of the financing will be used to build or acquire more production and manufacturing facilities, as well as sales and marketing initiatives. On the deal side, the Company is one of two that entered into a supply agreement with Canadian national pharmacy chain Shoppers Drug Mart. With recent financings, MedReleaf has about $200 million on its balance sheet and only $10 million in debt.
Conclusion
Overall, both companies have the potential to generate above-average returns for investors heading into recreational legalization in Canada. While MedReleaf has an edge in its production-cost profile, adequate financing and high margins, positioning the company very well for sustainable growth, Aurora Cannabis has the clear upper hand with higher production capacity, double-digit growth rate, and more international opportunities in addition to synergies from the pending CanniMed acquisition. Thus, Aurora Cannabis looks much more attractive from an investment perspective and has the potential to provide much higher returns as compared with shares of MedReleaf.
Disclosure: Neither the author nor his/her family own shares in any of the companies mentioned above.
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