Aurora Cannabis (NASDAQ: ACB) and Canopy Growth (NASDAQ: CGC) have been two of the more notable and recognizable cannabis companies within the industry during the past five years. But due to challenging market conditions, they have struggled, and their valuations have been falling, sharply.
Today, Aurora Cannabis has a market cap of around $380 million, while Canopy Growth is worth approximately $600 million. But five years from now, I expect that delta to shrink. Aurora Cannabis will not just catch up to Canopy Growth but will overtake it in valuation. Here's why that could happen.
Aurora Cannabis' business has been moving in the right direction
In recent years, Aurora Cannabis hasn't been a safe company to invest in. But to the credit of CEO Miguel Martin and the company's management team, the cannabis producer has become leaner, its margins have been improving, and it is now even generating positive free cash flow.
The company reported earnings earlier this month, and for the period ending June 30, its net revenue rose by 12% year over year to 83.4 million Canadian dollars ($61 million) Its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) also rose by 87% to CA$4.9 million ($3.6 million), while free cash flow came in at a positive CA$6.5 million ($4.8 million). In the prior-year period, this figure was a negative CA$11.7 million (negative $8.6 million).
As Aurora Cannabis expands into more international markets and grows its operations, these numbers are likely to improve. The medical-marijuana segment has better margins than the consumer business, which Aurora has been pivoting away from in recent years, which is why it may not be surprising if the company's top and bottom lines continue to trend in the right direction in the future.
Aurora's improved financial performance is a key reason the stock has risen by more than 45% this year (Canopy Growth is up around 38%), and it could climb even higher over the next five years.
Standing pat and waiting for U.S. legalization may hurt Canopy Growth's valuation
While Aurora has been looking at international markets to expand into, Canopy Growth has remained razor focused on expansion into the U.S. cannabis market. In theory, it's a great opportunity because the U.S. market will be the largest pot market in the world. The only problem is that due to the federal ban on pot, Canopy Growth can't simply expand there.
Canopy Growth has been slimming down its operations to reduce cash burn and costs. But its sales have declined 15% as a result of that to CA$75.8 million ($55.5 million) for the period ending June 30. And despite its efforts, it's still struggling with profitability and cash flow. In its most recent quarterly report, its adjusted EBITDA was a negative CA$5.3 million (negative $3.9 million) versus a loss of CA$23 million ($16.6 million) in the prior-year period. While that has improved on a year-over-year basis, investors may have been expecting better results by now. Meanwhile, the company's free cash flow was a negative CA$55.7 million (negative $40.8 million) during the period.
The risk I see is that in a worst-case scenario, legalization doesn't take place in the U.S. within the next five years and Canopy Growth continues to get smaller in sales and valuation. And even under the best-case scenario where legalization does occur, the company may spread itself too thin to pursue those new opportunities. Without strong operations today and lots of competition in the U.S., Canopy Growth could end up in a familiar situation of expanding too quickly and doing so without much regard for its bottom line. In either situation, it wouldn't surprise me to see the end result being the same: a lower valuation for Canopy Growth stock.
Both of these stocks come with significant risk
Regardless of whether you think Aurora is a better buy than Canopy Growth or vice versa, there's still a lot of risk with investing in these cannabis companies. Due to the changing industry conditions, growing competition, and lots of volatility in their underlying-earnings numbers, these aren't stocks which will be suitable for most investors.
In five years, these stocks have both fallen by more than 97% in value, and they make for extremely risky, contrarian investments to put into your portfolio. But I believe there is a bit less risk with Aurora Cannabis moving forward and that in five years, with better margins and potentially higher sales volume, it could be worth more than Canopy Growth.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
