Prediction: Aurora Cannabis will be worth more than canopy growth in 5 years

Aurora Cannabis (ACB 5.51%) and Canopy growth (CGC 1.14%) have been two of the most notable and recognized cannabis companies in the industry over the past five years. But due to difficult market conditions, they have struggled and their valuations have plummeted.

Today, Aurora Cannabis has a market cap of about $380 million, while Canopy Growth is worth about $600 million. But five years from now, I expect that delta to shrink. Aurora Cannabis will not just catch up with Canopy Growth, it will surpass it in valuation. Here’s why this might happen.

Aurora Cannabis’ business was headed in the right direction

In recent years, Aurora Cannabis has not 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 turned leaner, its margins have improved, and it’s now even generating positive free cash flow.

The company reported earnings earlier this month, and for the period ended June 30, net income rose 12 percent year over year to C$83.4 million ($61 million). it also rose 87% to $4.9 million ($3.6 million), while free cash flow was positive at $6.5 million ($4.8 million). In the prior-year period, this figure was negative $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 moved away from in recent years, so it may not be surprising if the company’s top and bottom lines continue to trend in the right direction going forward.

Aurora’s improved financial performance is a key reason why the stock is up more than 45% this year (Canopy Growth is up about 38%) and could rise even more over the next five years.

Holding back and waiting for US legalization could hurt Canopy Growth’s valuation

While Aurora looked to international markets to expand, Canopy Growth remained focused on expanding into the US cannabis market. In theory, it’s a great opportunity because the US market will be the largest pot market in the world. The only problem is, because of the federal ban on pot, Canopy Growth simply can’t expand there.

Canopy Growth has scaled back operations to reduce cash burn and costs. But its sales fell 15% as a result to $75.8 million ($55.5 million) for the period ending June 30. And despite its efforts, it still struggles with profitability and cash flow. In the most recent quarterly report, adjusted EBITDA was negative $5.3 million ($3.9 million negative) versus a loss of $23 million ($16.6 million) in the prior-year period. While this improved year-on-year, investors would have expected better results by now. Meanwhile, the company’s free cash flow was negative $55.7 million ($40.8 million negative) during the period.

The risk I see is that, in the worst-case scenario, legalization doesn’t happen in the US for the next five years, and Canopy Growth continues to decline in sales and valuation. And even in the best-case scenario where legalization happens, the company may spread itself too thin to pursue those new opportunities. Without strong operations today and plenty of competition in the US, Canopy Growth could find itself in a familiar situation of expanding too quickly and without much consideration for its bottom line. Either way, I wouldn’t be surprised to see the end result be the same: a lower valuation for Canopy Growth stock.

Both stocks come with significant risk

Whether you think Aurora is a better buy than Canopy Growth or vice versa, there are still many risks to investing in these cannabis companies. Due to changing industry conditions, increased competition and a lot of volatility in their underlying numbers, these are not stocks that will be suitable for most investors.

In five years, these stocks have both fallen over 97% in value and are extremely risky, contrarian investments to put in your portfolio. But I think there’s a little less risk if Aurora Cannabis moves forward, and that in five years, with better margins and potentially higher sales volume, it could be worth more than Canopy Growth.