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Aurora CEO: No 'awkwardness' as big pot taps craft cannabis for answers

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Aurora screens thousands of pot strains per year for use in its future products at its Aurora Coast facility in Comox, B.C. (PROVIDED)
Aurora screens thousands of pot strains per year for use in its future products at its Aurora Coast facility in Comox, B.C. (PROVIDED)

With Canada weeks away from legalizing recreational pot in the fall of 2018, Aurora Cannabis (ACB.TO)(ACB) executives boasted to analysts about the massive, low-cost crops they could grow inside futuristic, highly-automated "Sky Class" cultivation facilities. The first, Aurora Sky, was already fully operational, they said on a Sept. 25 post-earnings conference call.

Billed as one of the largest marijuana production facilities in the world, with a footprint larger than 16 football fields, Aurora's sprawling flagship greenhouse near Edmonton International Airport has been running at a quarter of its designed capacity since mid-December. Last month, in its latest bid to streamline operations, Aurora announced the closure of Aurora Polaris, a smaller production facility about a kilometre away.

Shrinking square-footage and staff levels have been the norm for some time at major Canadian licensed producers. Companies still face the grim task of eliminating infrastructure and jobs that helped grow a costly, industry-wide glut of pot that didn't sell in a smaller-than-expected market. Now, many of the biggest producers are desperate to shift their sales away from bargain-priced weed towards the pricier, higher-potency, terpene-rich cultivars that craft cannabis producers with roots in the pre-legalization market have specialized in for years.

For Aurora CEO Miguel Martin, the push to premium means being deeply vested in the opinion of people like Gord Nichol, owner of North 40 Cannabis, a self-described "Ma and Pa" pot producer based in Nipawin, Sask. Their connection speaks to how Martin hopes to revive his company's dwindling recreational sales, as well as simmering tensions between big corporate cannabis and small craft producers.

'A real sh**-show'

Last November, Nichol announced on Twitter that he would be shutting down his facility due to an outbreak of powdery mildew. Making matters worse, he says, the new genetics he ordered from a supplier to replace the contaminated crop showed up with insects and diseases.

"I was a real sh**-show," he told Yahoo Finance Canada in an interview.

Shortly after complaining on Twitter, Nichol received an offer from Charles Pick, senior vice-president of science and innovation at Aurora. Pick manages the Aurora Coast facility in Comox, B.C., where the company screens thousands of pot strains per year for use in its future products.

"He asked if I'd be willing to run their genetics. After quite a few conversations, I decided I would take a chance on them," Nichol said.

"Because of where I came from, the legacy market, there was some concern that there would be negative connotations with me working with a large corporation such as Aurora," he added. "I'm not a corporate cannabis guy by any means. In fact, you'll likely find me railing against them rather than supporting them."

"Farm Gas," as the Aurora-sourced genetics came to be known, has the makings of a commercially successful cannabis strain, with a frosty appearance and THC levels tested above 30 per cent.

"There were questions about whether Aurora is capable of producing this type of genetics," Martin told Yahoo Finance Canada. "Having someone like Gord validate it was really a big deal for us."

Martin says Aurora will launch Farm Gas "under our portfolio in a little bit, after [Nichol] is done with it." Nichol says he hasn't hammered out the final details of the agreement with Aurora.

He notes North 40 is not the only craft producer testing strains from the company's extensive seed bank in Comox.  

"We think there is a big opportunity to monetize Aurora Coast, whether that's through our own sales or through others," Martin said. "We're screening 7,000 or so [strains] a year. It's going to be a big part of our economic model going forward."

Aurora's sales need help. The company sold less than half as much non-medical cannabis in its most recent quarter than it did in the same period back in 2019. Recreational sales plunged 45 per cent year-over-year in the three months ended June 30, even as Statistics Canada booked a series of monthly retail sales records.

Aurora says it's shifting focus to medical cannabis, where the company commands a top market share position in Canada. But Martin refuses to fully pivot away from the larger recreational market.

"Just look at their recreational market share. It's dropping. That's all because of small producers bringing in better products," said Nichol, referring to large Canadian cannabis producers in general. "Honestly, they haven't performed very well. A lot of people lost a lot of money [in the stock market], and continue to do so."

Asked what he would do in Martin's shoes, Nichol replied: "I don't know if I'd want that job."

'Eyes on every plant'

Aurora's rivals are bolstering their top-shelf cannabis offerings. Canopy Growth (WEED.TO)(CGC) announced a deal in April to acquire The Supreme Cannabis Company, known for its premium 7ACRES brand. In July, Entourage Health (ENTG.V) (formerly WeedMD) acquired CannTx Life Sciences, a craft grower specializing in small-batch production.

In June, Aurora released a trio of new strains from Aurora Coast's genetics program under its premium San Rafael '71 brand. While Nichol is quick to praise the team in Comox, and is currently working with another cultivar from Aurora dubbed "Sourdough," he's unsold on growing top-quality product at a scale meaningful to Aurora's balance sheet.

"I don't believe that premium cannabis is scalable to the levels they're attempting. I could be proven wrong. But so far, I've been proven right," Nichol said. "You've got to have eyes on every plant, every day."

As CEO of one of the world's largest cannabis companies, Martin naturally believes scale and quality are not necessarily at odds.

"I wouldn't say there's an awkwardness," he said. "Look at something like Johnnie Walker Blue. Most people will tell you it's a phenomenal product, and it comes from one of the largest spirits companies in the world. We have to prove to people that we can do that."

Discounted to death

While they may not see eye-to-eye on the amount of human contact needed to grow high-end cannabis, the unlikely pair are united in their distaste for something else: falling pot prices, and the large-format bags of bargain cannabis that surged in popularity at the start of the COVID-19 pandemic.

For Martin, Aurora's "Daily Special" discount line is a growing drag on the company's financial performance.

"If you look at the margins of discount flower, in many cases, at best, it's break-even. And in some cases in certain big provinces, they're negative," he said on a Sept. 27 call with analysts following the release of the company's fourth-quarter financial results

Last month, Cantor Fitzgerald analyst Pablo Zuanic estimated that "Daily Special" represents 85 per cent of Aurora's flower sales, up from 20 per cent in the first quarter of 2020. The average retail price, he said, has dropped below $5 per gram, compared to $5.70 when "Daily Special" launched.

Price compression since recreational legalization has prompted a number of craft producers, including North 40, to call on Ottawa to change its cannabis excise tax regime. The current duty is $1 per gram of dried flower, or 10 per cent of the value of the gram, whichever is greater. Lower pieces mean that $1 represents a larger share of the company's margins.

"The big corporations continue to sell at a loss, and be subsidized by shareholders. It continues to drive down the price of cannabis. That impacts the small guys first," Nichol said.

"A lot of these small crop producers aren't going to make it."

His ire for corporate cannabis softens when he speaks about the genetics and support he's received from the Aurora Coast team.

"They stepped up and provided what many small legacy producers couldn't. I'm glad I put my preconceived notions aside, and decided to go with them," Nichol said. "They might have saved my company. So, I'm forever in debt for that."

Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.

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