Canaccord Sees Aurora Cannabis (TSX:ACB) at $11 a Share

James West
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Aurora Cannabis Inc (TSX:ACB) (OTCQB:ACBFF) (FRA:21P) is expected to hit $11 a share again, according to Canaccord Genuity Group Analyst Matt Bottomley. He published last week citing “the coming together of two industry giants”. He suggests “After consolidating MedReleaf into our model, our FY2019 revenue forecast increases to $512M (from $336M) and EBITDA increases to $171M (from $114M).”

Transcript:

James West:    Hey there, welcome back to Midas Letter Live. My guest in this segment is Matt Bottomley, who’s been here a few times before. He’s the equity analyst at Canaccord Genuity. Matt, welcome back.

Matt Bottomley: Good to see you again, James.

James West:    Matt, you recently published on Aurora Cannabis, and kind of a timely story in that they’ve just completed their merger with MedReleaf. So that puts 386 million MedReleaf shares in the wind, so to speak.

Matt Bottomley: Right. So yeah, I mean, this has been a deal that was announced maybe a month or two ago, so it’s been a long time coming, I think. I think M&A is to be expected in this space, and now we’ve combined arguably by infrastructure built and some other metrics, probably the number two and the number four name in the space by size into what could be the largest entity, now. So currently, Canopy and Aurora are certainly the leaders by market cap and many other metrics.

James West:    Okay. So is Aurora now the biggest by market cap than even Canopy? Or are they more or less at the same level?

Matt Bottomley: Well, I mean, they’re trading at similar levels right now. Canopy is trading a bit higher on an absolute basis, but I think if you look at the recreational market, potential brand awareness – although branding is going to be quite challenging for all these LPs – how many provinces LPs are in, built infrastructure, Canopy is definitely the largest company in the market. But I think that when you look at the medical side of things, we have Aurora that’s, I think, acquired two of the top three names in the space when it comes to medical, that being CanniMed, now MedReleaf. I believe CannTrust is another quality name, as well.

So I’m not forecasting any future M&A on that front when it comes to what Aurora might be doing on its medical side, but I think they clearly have the number one spot by size and scale, and potentially expertise, when it comes to the medical side of things – which is likely going to get higher pricing over the long term in terms of retail pricing. It’s likely going to have a very compelling growth profile as well. I think we’re probably only 30, 40 percent ramped up of our medical patient base in Canada. And when it comes to the international opportunity, which a lot of these LPs are getting into, Aurora is still a top three name when it comes to international exposure, and with medical expertise – because remember, all these international markets are medical – they might have the best shot at carving out market share internationally, which, you know, if you use Germany as the proxy, that’s expected to be a fully reimbursed market and can push margins and pricing up higher. So very favourable on this deal; by far the largest deal we’ve seen in the cannabis industry so far.

James West:    Sure. Do you think that Aurora’s apparent focus on medical acquisitions as opposed to brands more oriented towards recreational, do you think that’s going to perhaps cause more of a perception in the investor marketplace that Aurora is the medical play and Canopy is the rec play?

Matt Bottomley: No, not at all. I think that Canopy certainly, I think, in most investors’ minds, and also people that I just talk to anecdotally that have, you know, they’re not in capital markets, they’re not investing, they know Canopy as Tweed. Like, everyone knows Tweed; I was up by Wasaga Beach last week and I saw a huge Tweed Canopy at an event, so they’re everywhere, and I think that they certainly likely have the significant edge when it comes to general public awareness going into the rec market. But I don’t think Aurora at all is a medical name over a recreational name. I mean, the provincial purchase orders we’ve seen come in, MedReleaf and Aurora have the second-largest after Canopy of commitments so far that have been made public.

So I think what Aurora is focused on this deal isn’t ‘we’re going to now be medical versus rec’, I think it’s, they want technologies, which of course, and know-how and expertise, which of course is going to be important in the medical market; but it’s also going to be critical into making higher-margin products like vape pens and edibles and tinctures, which are already in the market. You know, transdermal patches, things like that – you can take technical medical expertise in how you make different product formulations, and you can roll that into the rec market as well when it comes to product breadth. So I don’t really think they think of it, at least in my view, that they’re thinking of it as, okay, now we’re pivoting to medical versus rec; they will be a top three name, in my view, by market share, in the rec market as well.

James West:    Mm-hmm. So then, one is compelled to ask a chartered financial analyst: why the sell-off in Aurora?

Matt Bottomley: I’m not a chartered financial analyst.

James West:    Oh?

Matt Bottomley: But I am a chartered accountant.

James West:    Okay.

Matt Bottomley: There’s a lot of things there, it’s hard to –

James West:    I’m sorry.

Matt Bottomley: In any event, I mean, it’s hard to know. With this market, I think that, you know, I look at it on a fundamental basis, one-year forward targets; but even in my overall views are many, many years out. So why they trade, you know, one day versus another – it could be certain shareholders that, you know, get their shares and want to crystallize their investment. It could be the borrow rates on the short side swing in the wind week over week; I don’t follow those personally, not on the trading side, so maybe those rates have come down and there’s more borrow out there for people that want to take a short position. I couldn’t tell you specifically. I don’t know how accretive this deal is; I think it really adds the two behemoths in the industry together, and I’m sure there will be efficiencies and accretion over the long term, but I think just keeping up with scale, like a company like Canopy, is critical if you want to be one of the top two, three, four, five names in the market, which I believe it’s going to consolidate down to eventually.

James West:    Sure. So then, Aurora, you’ve got an $11 target on Aurora long-term, then the, you know, the takeaway from that is that the cheaper Aurora gets in the current selling environment, the more of a buy it becomes?

Matt Bottomley: Oh, I’m certainly a buyer at these levels, even obviously when I published the note before a bit of a – I wouldn’t call it a sell-off, but it’s pulled back a bit. And just the reason for that is, if you look at where the market is going internationally, there’s really three companies, in my view, that have a very significant edge in potentially getting international inroads. I don’t want to say that, you know, the German or Australia or Latin American markets are sure things, but I definitely think Canadian LPs are going to be a part of that, and Canopy, Aphria, and Aurora/MedReleaf have a lead in that segment by far. So I think it’s, you know, there’s a very favourable growth profile and very favourable optionality still in Aurora’s name, and that’s even in addition to ahead of recreational Canadian sales ramping up.

James West:    Right. The whole market has sort of demonstrated or gone into a phase of weakness in that their share prices are drifting lower. Do you think that there is a sense that the Canadian market has reached a level of maturity that makes the US market more attractive, or at least, US companies traded in Canadian stocks?

Matt Bottomley: Yeah, there’s a number of ways to divide that up. I think that, you know, we’ve seen a lot of headline in the Canadian space when it comes to this recreational market coming out. I think there’s a bit of sell on news potentially when there’s been all of these positive headlines for a year or two years now. So I think we’ve seeing a bit of fatigue on the LP side, in my view. The macro valuations in the Canadian market, sometimes it’s as much as 40 billion, sometimes 30. That can’t be supported just by Canadian fundamentals. So that’s telling you that, A) there’s too many players in the space, which I believe there are, or B), maybe investors are starting to bake in more value for these international optionality, the fundamentals that come from other countries.

So I think because of that, there is a lot more attention going to these US names, partially because there’s just a vast US pipeline coming to market. We’ve seen MedMen and GTI, you know, companies like Trulieve and other US plays that are either coming to market or are already here, in addition to legacy names that I cover, like iAnthus and MPX and names that I’m very favourable on. So the US names certainly trade at a very, very steep discount in valuation to the Canadian names, and I expect that to somewhat normalize over the next year, which is why I put so much of my focus on those US names.

James West:    Sure. Have you got any more of a sense, politically, when we might expect de-prohibition broadly, Federally, in the US?

Matt Bottomley: No, but I can tell you there’s a lot of incremental data points to track. I don’t think this going to come as one big headline news, you wake up in the morning next week and all of a sudden it’s not a Schedule I drug; I think you’re going to see incremental data points. So GW Pharma’s trial of Epidiolex, which was passed by the FDA, now contradicts the DEA’s stance that being Schedule I meaning that cannabis causes harm. So you have two Federal agencies in the US saying two different things; whether or not there’s any pressure to change that, I don’t know.

You know, you have the Farm Bill that might be signed in the coming months, which might allow, you know, looser – I guess more ability for hemp-derived products to be shipped, potentially, into large distributors like a Costco or something, around the US. So there’s definitely incremental data points to track. I think the midterm elections this November is one, and I think coming into 2020, if there’s no significant movement, cannabis legalization is a great issue for either a Republican or a Democrat to try and tackle, because 65 percent of the US Americans believe that cannabis should be legal for recreational purposes, and it’s like 99 percent for medical. So I think it’s just an issue of when, not if, it’s going to happen, but trying to handicap the month or quarter that’s going to happen – you know, you just got to track the data points as they come. But it’s moving; it’s moving in the right direction.

James West:    Yeah, sure. Okay, so then, people would ask me, so I’m going to ask you – I’m going to foist this off on you.

Matt Bottomley: Sure.

James West:    A lot of individuals out there opining that, you know, the Canadian market is mature, and therefore there’s not -everything’s going to go to the US. To which my normal response is, oh, no, there are quite a number of value catalysts left on the Canadian side that will catalyze an accumulation phase again towards the end of the summer, is my belief, though I don’t want to be held to that timeline.

Matt Bottomley: Sure.

James West:    What are the value catalysts, from where you sit, in the Canadian space that may yet catalyze more accumulation?

Matt Bottomley: Sure. Well, I think that if someone’s saying the Canadian market is mature, what they might mean is overvalued, because there’s no way this market is even close to mature, whatsoever. I mean, we haven’t even kicked it off. But there are a good number of catalysts. We’ve seen some LPs, I guess some provinces’ press releases licensed producers that are going to get purchase orders from the Alberta government and BC government; not a lot of clarity in that, but you can see BC is having a wide net, 31 licensed producers. Canopy and the larger LPs are only getting about 5,000 to start, so that’s much less than their proportionate market share in other places.

Ontario is a huge catalyst coming up. It seems to me like it might be a little more auction-style, like there might be very short term rolling basises [sic] for those purchase orders, but I think you’re going to be able to see in the next little while which licensed producers might have a better inroad. Because at the end of the day, this market is eventually going from what is right now the cost of admission of being a cultivator and a farmer, to consumer packaged goods, to having shelf space in the prime areas, in the LCBO, in the SAQ models that are going to be rolled out.

So that’s a catalyst. I think Shoppers Drug Mart finally announcing that they have a sales license to distribute medical cannabis online will be a huge catalyst. Now, that might actually be unfavourable, quite frankly, to the LPs that have the contract on a pricing perspective, but it might also crystallize their market share in the medical market, because I believe Shoppers Drug Mart is going to be potentially more aggressive in pricing than what the wholesale market is right now, LP to LP, or through the government.

So these are all catalysts, and then of course, October 17th, huge news catalyst. I think that different provinces are going to probably execute in different ways. I look at the Ontario government as probably maybe some short term pain, maybe long term gain, in a catalyst with Doug Ford’s government potentially wanting to privatize the retail side. Now, we’re coming very close to October 17th; I mean, just yesterday, it felt like it was March, so it’s going to come pretty quick, and to all of a sudden pivot on that now, I have no idea how they can do that. Using sort of the Wynne legacy plan of having 40 stores open in the first year, I’ve heard of four myself, and I’m pretty plugged in, talking to investors and stakeholders every day. So I don’t know how that’s going to roll out. I think there’s going to be some negative news headlines, quite frankly, in maybe Ontario, but if it privatizes over the long term, it’s much more favourable, assuming the LPs are allowed in.

So there’s a number of catalysts to look out for, and they always sneak up on me. I’ll wake up Monday morning not expecting, and then, off to the races.

James West:    There you go. So, lots left to come in the Canadian cannabis space.

Matt Bottomley: Absolutely.

James West:    All right, Matt, that’s great as usual. Thanks for coming in today.

Matt Bottomley: Anytime.

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James West

James West

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I employ a Capital Efficiency Model that dictates money should never be exposed for longer than is absolutely necessary to the possibility of being lost. Thus, I routinely sell half my position when a stock doubles from my entry price, and I sell stocks that lose 20%, unless there are...
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