Aurora Cannabis (ACB - price target), along with its other Canadian-based peers, continues to have the challenge of black market pot producers and sellers to contend with, which are able to offer marijuana for far less of a price than legal producers.
In this article we'll look at the reasons behind the staying power of the illegal pot producers and how it's likely to play out over the next year or so for Aurora Cannabis, and the Canadian cannabis industry in general.
The reasons behind the robust black market
There are several reasons the black market has performed better than expected against the legal cannabis operators in Canada. They include not having to pay fees and various taxes, an entrenched loyal customer base, and the extremely slow licensing process which has significantly reduced competition in various geographical areas.
About the only thing there can be nothing done about from the side of Aurora Cannabis and other legal operators is in regard to the entrenched customer base. Many of them, for a long time, have been very wary of the government, and they aren't likely to change the way they buy pot unless the government cracks done on the larger illegal producers. While that is a likely probability, I don't see that happening until the desired number of retail outlets are in play.
Once that comes about, I think there will be a crack down on the black market in order for the desired tax revenue to reach its expected potential. For now, there's not much Aurora can do other than offer quality alternatives that some long-term users are willing to try.
As for the legal market at this time, much of the growth isn't going to come from the black market gravitating toward them, but from those that haven't used marijuana much, if at all. Concerning the medical cannabis segment, I believe the legal market will blow the black market away. Aurora is positioned well to take full advantage of that as that market continues to grow; not only in Canada, but around the world. Including Canada, Aurora has a presence in 25 markets, with 23 of them only allowing medical cannabis sales.
How Aurora can win the black market battle
For now the black market looks formidable and difficult to compete against, but there are a number of positive things happening that will allow Aurora to do very well against illegal producers over the long haul.
As mentioned above, fees and taxes, on the pricing side of the business, put Aurora at an immediate disadvantage. That, coupled with the slow licensing process in Canada has allowed the black market to flourish.
On that count, there is nothing Aurora or any other legal company can do unless and until those things change. Fees and taxes, if they are changed, will probably not happen in the near future. If there were positive changes made, the competitive landscape of the legal producers against the black market will probably have worked its way out, because it would take awhile before that would happen, in my opinion.
As for the licensing issue, that is slowly improving, and eventually that will be a positive outcome for Aurora, which hasn't been able to compete near its potential because of the lack of retail outlets to sell in. That's particularly true of Toronto and Ontario, where just a short time ago there were only a handful of places to legally buy pot. That's hard to believe when those are the most important markets in Canada in relationship to the potential consumer base.
Having only a few places to acquire cannabis has allowed the black market to control the market. Also, because of lack of scale, Aurora is limited on its earnings potential, even though it still maintains a respectable gross margin.
Aurora has no control on either of the above. What it does have control over is the quantity and quality of the cannabis is grows, and in that regard it's second to none in the Canadian market.
It shouldn't be long before Aurora meets its goal of cost per gram of $1.00 or lower. That will allow it to endure the temporary limitations associated with competing against the low-cost black market producers, while improving its bottom line. Most smaller producers will struggle to compete against Aurora on that front.
Aurora has all the pieces in place to successfully combat the black market. All it has to do is continue to reduce the cost per gram as it boosts production capacity. All of that will improve through at least the middle of calendar 2020, when it'll have funded capacity of 625,000 kilograms annually.
As time goes on, and things like vaping products sold through illegal vendors are reported on in the media concerning their negative impact on health, more people will decide to go with safer, legal products, which will be a positive catalyst for Aurora.
The battle between Aurora Cannabis and Canadian black market producers and sellers is one that can be won. Things will change dramatically as more licenses are awarded and a significant number of legal retail outlets are operational.
None of the illegal producers can come close to Aurora's scale. As it continues to reduce prices and increase capacity, it'll shrink the prices of its products to being more competitive.
Contrary to assertions made by some, Canadian demand isn't being overwhelmed by too much supply, it's being hindered by the lack of retail stores potential consumers can buy cannabis from. As retail outlets grow, Aurora and others will be able increase its sales while reducing the size of the black market. Some of its peers will contribute to the same outcome.
Although the Canadian black market has been presented as a difficult foe to win against, the reality is it continues to flourish because of things outside of the control Aurora Cannabis and the legal cannabis market.
That is changing, and Aurora has already positioned itself, by its business model, to compete strongly against the black market and its legal peers.
And since Aurora has the long-term goal of being primarily a medical cannabis company, it will continue to grow in that segment, which I don't think the black market can compete against because of the growing negative sentiment concerning unregulated and potentially harmful products.
For the reasons stated here, I see it being only a matter of time before Aurora breaks out on a sustainable basis and overcomes the negative impact of the black market on its business.
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