Since peaking in just short of a year ago, most cannabis stocks seen nothing but red. Aurora Cannabis (NYSE:ACB) stock features in the list of worst performers. Shares currently trade at $1.68, down 83% from a 52-week high of $10.32 in mid-March 2019. While a short-term technical bounce is likely from oversold levels, I remain bearish on Aurora stock.
Before talking about some key points in Q2 2020 results and other reasons to remain bearish, the following point is worth noting — Aurora Cannabis expects the total size of the cannabis industry at $200 billion. The company has an annual production capacity of 150,000 kg and is operational in more than 20 countries.
These numbers seem big, but the stock has crumbled. So it’s important to understand the reason for this divergence.
My view is as follows: The marijuana industry is still at an early stage of growth and the inflection point is still years away. For cannabis companies and investors, this reality is gradually sinking-in.
Aurora Cannabis is likely to see years of cash burn through investment in medical research and significant marketing expenses. The same holds true for other cannabis companies.
The coming quarters and years will not decide the market leader. It will decide on the companies that eventually survive. For Aurora Cannabis, deciding to eliminate 17% to 18% of its workforce is a survival decision.
More such decisions are expected in the coming quarters that target to arrest cash burn. A very likely step is to focus on few countries than target multiple regions as it increases the cost.
Important Observations From Q2 2020 Results
Aurora Cannabis recently announced Q2 2020 results and there are multiple points that back a bearish view on the stock.
For Q2 2020, Aurora reported revenue of 56 million CAD ($42.2 million), which was just 3.4% higher than Q2 2019. Further, EBITDA level loss was 80.2 million CAD for Q2 2020 as compared to 44.7 million CAD for Q2 2019.
Even with operational presence in multiple markets, top-line growth is disappointing. To add to the woes, cash burn has accelerated.
For the first half of 2020, Aurora reported cash used in operations of 229.6 million CAD as compared to cash used of 132.9 million CAD in the comparable period for 2019.
With a cash buffer of just 156.3 million CAD, Aurora Cannabis will soon require funding. Therefore, more dilution of equity is coming in 2020.
While I am making a year-on-year comparison, it is worth noting that revenue for Q2 2020 declined by 26% from Q1 2020. For high growth industries, sequential revenue decline is a disappointment and underscores my view that inflection point is still years away.
Furthermore, medicinal cannabis and consumer cannabis net revenue also saw a sequential declined in Q2 2020. Aurora has been talking about the launch of Cannabis 2.0 products, with 23 SKUs — including vapes, concentrates, gummies, chocolates, baked goods and mints — introduced in December 2019. The coming quarterly results will be critical as it will provide insights on the impact of new product launch.
Even in the medicinal cannabis segment, growth is years away. Aurora is doing the right thing by focusing on clinical research. The research areas include pain, epilepsy, anxiety, cancer, and neuro-degeneration, among others. Only when clinical research establishes the benefits and the FDA gives an approval, will Aurora see growth in medicinal cannabis.
Last Word on Aurora Stock
In the coming quarters, Aurora Cannabis is likely to be a leaner organization with a relatively conservative growth strategy. This will help in conserving cash for an extended period of slow growth.
According to the U.S. National Institute of Drug Abuse, cannabis has several negative effects on health. Just as an example, brain development and memory is effected. These observations can translate into a regulatory headwind for recreational cannabis in the long-term.
Overall, there are multiple challenges to navigate and that makes Aurora stock unattractive even after a sharp decline. There can be short-term trading opportunities from oversold levels, but ACB shares are far from being a core portfolio holding.
Faisal Humayun is senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
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