The entire market has rallied in late August amid easing trade tensions, as both U.S. and China trade officials have said that the two countries are resuming trade talks. Since the favorable trade chatter started on Aug. 23, the S&P 500, Dow Jones, and Nasdaq are all up about 3%.
Marijuana stocks have not jumped along with the market Shares of Aurora Cannabis (NYSE:ACB) – one of the biggest companies in the Canadian cannabis market – have fallen since Aug. 23. This relative weakness is nothing new. Over the past three months, all three major indices have posted gains of around 4%-5%, but Aurora Cannabis stock is down more than 30% over that stretch. ACB stock has underperformed over the last six months, too.
The underperformance of Aurora Cannabis and all marijuana stocks indicates that investors’ views of these equities have become so negative that not even stock market rallies have been able to save Aurora Cannabis from its multi-month slide.
The long-term growth fundamentals of Aurora Cannabis stock, however, remain favorable. These fundamentals indicate that ACB stock can rise tremendously from today’s depressed levels. But it’s important to note that while fundamentals ultimately dictate long-term price movements, perception dictates near-term price movements.
Thus, Aurora Cannabis stock increasingly looks like a “near-term pain, long-term gain” name. In the long-term, it can climb a great deal. But, until perception turns around, ACB stock won’t rebound from this multi-month slide.
ACB’s Long-Term Growth Fundamentals Remain Favorable
The long-term growth fundamentals of Aurora Cannabis remain very favorable.
The long-term bull thesis on ACB stock is based on three points. First, the global cannabis market will be huge one day. Second, Aurora Cannabis will be a sizable player in that gigantic market. Third, the price of ACB stock does not reflect its ability to turn into a sizable player in the soon-to-be huge cannabis market.
On the first point, current consumption trends indicate that consumers don’t just like to consume cannabis, but that they like to do so nearly as much as they like to smoke tobacco and drink alcohol. Due to changes in perception around the world, cannabis appears to be on a fast-track to global legalization. This combination indicates that the legal global cannabis market will one day be nearly as big as the global tobacco and alcoholic beverage markets. Those are multi-hundred billion dollar to trillion dollar markets.
As far as the second point, Aurora Cannabis is the second-biggest player in the Canadian cannabis market today, behind only Canopy Growth (NYSE:CGC). Thus, Aurora doesn’t have to grow its market share over the next decade; it just has to defend its share. That seems doable, considering the company has been beating its peers over the past few quarters with huge volume growth, has a global distribution footprint that is second-to-none, and is one of the largest legal growers of cannabis in the world. Thus, Aurora should become a sizable player in the soon-to-be multi-hundred-billion-dollar global cannabis market.
Moving to the third point, the global tobacco and alcoholic beverage markets have each spawned several $100 billion-plus companies, and many more $50 billion-plus companies. The cannabis market should do the same. ACB could very well be one of those $50 billion-plus or $100 billion-plus companies. Aurora Cannabis has a $6 billion market cap today. Thus, either way, ACB stock’s potential upside in the long-run is huge.
Perception Issue Continue to Weigh on Aurora Cannabis
Although the long-term growth fundamentals supporting ACB stock remain favorable, the perception of ACB has become increasingly unfavorable over the past few months. Because perception drives near-term stock price movements, this deterioration has weighed on Aurora Cannabis stock.
The unfortunate reality is that negative perception will continue to weigh on ACB stock for the foreseeable future.
The current status of the cannabis sector is not pretty. Its volume and sales growth look fine. But the problem is that its growth is being driven by large investments. That is, everyone is spending a great deal on developing new products, building infrastructure, marketing to potential customers, etc. There has also been a great deal of price cutting across the sector.
As a result, cannabis companies’ margins are getting killed, and their cash is getting burned. That’s a big problem for Aurora Cannabis. Unlike many of its peers, Aurora does not have a large balance sheet. It had less than C$350 million of cash at the end of last quarter. Over the last nine months, its operating business has burned through nearly C$200 million.
Thus, ACB does not have a great deal of cash, and it’s burning money at an alarming rate. In fact, given its spending, it’s questionable how much longer the company can keep its doors open.
But, in the big picture, I don’t think this is an issue for ACB stock. Early leaders in young, high-growth markets frequently experience similar scenarios. They spend a great deal and burn through a lot of money in order to capture market share early-on, establish themselves as a market leader, and then reduce their spending as their market matures and rationalizes. Consequently, their profitability rises,. Aurora is following this playbook. which was also used successfully by Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX). It will work for Aurora, too.
But, this playbook is always accompanied by growing pains. Aurora Cannabis is in the middle of those growing pains right now. As long as those pains hang around, ACB stock will have trouble rallying.
The Bottom Line on ACB Stock
I like Aurora Cannabis stock’s long-term outlook, because this company looks poised to become a sizable player in a multi-hundred billion dollar industry. It also has the potential to generate high profits after growing for awhile.
But its bullish long-term outlook is being clouded by near-term growing pains. That is, in order to become prosperous in the future, Aurora has to spend a lot of money today. All that spending results in high cash-burn rates, which causes investors to freak out in the near-term.
As long as these cash burn concerns persist, Aurora Cannabis stock will have a tough time rebounding. As a result, ACB stock looks like a classic case of near term pain, long term gain.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
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