Investors bullish on cannabis no doubt are considering Aurora Cannabis (NYSE:ACB) stock right now. After all, currently below $2, Aurora stock looks cheap.
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I’m one of those investors who believes cannabis has a bright future. Indeed, I have a service, Cannabis Cash Weekly, dedicated entirely to the sector.
It’s true that short-term worries have pressured the industry over the past year. But investors need to take the long-term view. Indeed, I refer to this decade for the market as a whole as the Roaring 2020s — and I believe cannabis stocks will be some of the biggest winners over the next ten years.
However, I don’t believe Aurora stock will be one of those winners.
It’s when times get tougher that the quality of a company and a stock gets exposed. And as legendary investor Warren Buffett put it, “Only when the tide goes out do you discover who’s been swimming naked.” To stretch the metaphor, there are many cannabis stocks wearing much nicer clothing than Aurora Cannabis.
Investors can’t judge a stock looking at a single quarter. But recent results from Aurora and Canopy Growth (NYSE:CGC) highlight the difficulty in owning ACB stock.
Canopy remains one of my top pick in cannabis, and its earnings report showed why. The Canadian market is in upheaval. Regulator Health Canada has been slow to approve new retail locations, and overproduction plagues the industry.
Yet, Canopy grew its revenue 13% quarter-over-quarter. An excellent operator got it done.
Meanwhile, Aurora didn’t — as revenue declined almost 10% even excluding provisions for higher returns.
Canopy showed broad strength. Revenue rose not just in consumer sales, but in medical (+5%) and recreational business to business (+8%). Canopy is still generating losses, but top-line performance impressed amid challenging industry conditions.
Aurora Cannabis results, however, only give more cause for concern. Average recreational selling prices declined 10% QoQ despite the company shifting its production to higher-quality, higher-priced strains.
Wholesale revenues collapsed, falling by over 75%. Even medical sales weakened.
It’s an ugly quarter, pure and simple. And while Aurora stock rose on the news, that’s likely a “dead cat bounce” more than anything else. Shares already had declined 27% in a week after the company announced earlier this month that it would take non-cash charges totaling nearly 1 billion CAD. Meanwhile, the gains since earnings now have been nearly erased.
In announcing those charges, Aurora also announced that CEO Terry Booth was retiring. And some investors might see that as good news.
After all, the charges itself show the strategic missteps Aurora made under Booth. The company spent too much money on too many deals. And as a result, as I noted before earnings, its share count has ballooned.
It has well over 1 billion shares outstanding at this point, and many of them were issued to fund acquisitions that now are being written down. Canopy and Cronos (NASDAQ:CRON), backed by investments from Constellation Brands (NYSE:STZ) and Altria (NYSE:MO), respectively, had no such need for dilution. Tilray (NASDAQ:TLRY) managed to avoid the temptation, even as its stock price exploded higher back in 2018.
Booth follows Cam Battley, the former chief corporate office who departed in 2016. Battley, in my opinion, was the “Chief Cheerleader” not just for Aurora, but for the entire sector.
However, in this new environment, Aurora needed a different type of executive — one perhaps better-suited to run a multi-billion dollar business. Canopy, in fact, found that executive in David Klein, who moved from Constellation to take over as CEO in December.
How Aurora Stock Gets Fixed
Overall, the big risk is that it’s too little, too late for Aurora stock. Aurora closed calendar 2019 with only 156 million CAD in cash, and its adjusted EBITDA loss in the fiscal second quarter alone was over 80 million CAD.
Dilution isn’t the only issue here. Debt and cash are too. Aurora does have roughly 200 million CAD remaining on a so-called “at the market” program, in which it sells Aurora stock in the open market to raise cash. But those sales only pressure the stock price further.
Collectively, the company is trying to get by. It’s laying off close to 500 full-time employees, costs are being cut and Aurora hopes to pinch its pennies until the market grows enough to get EBITDA positive.
But, that’s not guaranteed. Aurora still has $345 million in convertible debt due in 2024 as well, and it’s unlikely the company can sell assets.
As David Klein told Reuters this month, “There’s not a lot of market demand for cannabis production facilities. There’s a lot of capacity in Canada and no logical buyers.” Businesses acquired overseas would have to be sold for pennies on the dollar or else Aurora wouldn’t have taken the nearly 1 billion CAD writedown.
Again, the entire sector has fallen over the past year — and from a long-term perspective, that selloff has gone too far. It provides a buying opportunity for long-term investors.
But the selloff in Aurora stock is different. The financial risks here are legitimate and significant.
To be sure, I don’t believe Aurora is going bankrupt in the next 12 months, or in the next five years. But simply surviving isn’t enough. Aurora has a market capitalization of nearl $2 billion, and that figure doesn’t rise just because Aurora avoids a restructuring.
That aside, there’s a simple question to ask: why Aurora? Cannabis bulls like myself believe the product creates a massive worldwide opportunity. Investors following that thesis should own companies who can actually take advantage of that opportunity.
Canopy and Cronos, with their war chests, can do so. They can spend up to establish and protect market share. They’ll be able to buy assets cheap as smaller players fail. They will plow hundreds of millions of dollars in research and development (R&D) spending into vapes, edibles and beverages — the products that can truly expand the market beyond core users.
However, Aurora won’t be able to do any of that. Cost cuts will include R&D and marketing, and its cash has to go to repay debt.
Therefore, in an opportunity this large, it pays to go with the leader.
Aurora’s initial strategy of buying exposure to every aspect of worldwide cannabis was supposed to make it the leader. But that strategy has failed, and left the company in a difficult spot.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.
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