Shares of Canadian cannabis producer Aurora (NYSE:ACB) have dropped steeply over the past few months as the once red-hot cannabis sector has lost its momentum. Over the past six months, Aurora stock is down 24%, while peers Canopy (NYSE:CGC), Tilray (NASDAQ:TLRY), and Cronos (NASDAQ:CRON) are all off nearly 40% or more.
Under the hood, the market is freaking out about the cannabis sector because:
1) the Canadian market isn’t ramping like it was supposed to,
2) movement on U.S. market legalization has been slower than expected,
3) margins have been adversely impacted by the industry’s obsession with production capacity expansions,
4) big money hasn’t moved into the space with as much frequency as investors initially expected, and
5) there has been some troublesome C-suite turnover at some of the biggest players.
A Closer Look at Aurora Stock
Aurora has been hit by four of these five issues. Cannabis revenue rose just 20% sequentially last quarter, versus 93% sequential growth the prior quarter, a byproduct of slowing growth in the Canadian market. Aurora has yet to announce extensive U.S. market expansion plans. Gross margins dropped 4 points year-over-year last quarter. And, the company still lacks a big money investment.
Net-net, the cannabis market hysteria has spilled over into Aurora stock. Shares are consequently in bear market territory.
This hysteria is creating a long term opportunity for several reasons. Namely, ACB stock is now materially undervalued, with multiple game-changing catalysts on the horizon. As such, I think this weakness is an opportunity. The stock may not turnaround right away. But, it will soon. When it does, Aurora stock could rally in a big way, very quickly, see Aphria (NYSE:APHA).
All in all, while I understand buying ACB stock here in the midst of a secular downtrend might be tough, I also think it’s a move that will pay off long term.
What’s Next for ACB Stock
In order to understand where ACB stock may go next, we have to first understand how it got to where it is today.
Right now, ACB stock is down 24% over the past six months and 40% off its 2019 highs, but the stock is also up nearly 25% year-to-date. Thus, what you have with Aurora is a stock that was red-hot to start the year (up 90% from January through late March) and which has since come crashing down.
ACB stock was red-hot in early 2019 because of two things: low rates and improving sales trends. The late 2018 market sell-off killed pot stocks. This was partly because rising interest rates killed investor risk appetite while the Canadian cannabis market actually started to flatten out in terms of demand.
As interest rates plunged in early 2019 and as the Canadian cannabis market regained its footing, however, pot stocks came roaring back. ACB stock was one of the biggest winners in the group because of its relative undervaluation (it was the cheapest of the Big 4 pot stocks at the start of the year).
Aurora stock has since reversed course alongside all other pot stocks because investor risk appetites have cooled and fundamentals have weakened. Specifically, escalating trade and geopolitical trade tensions have weighed on investor sentiment in this space, at the same time that most of the industry’s biggest players reported huge margin weakness this past quarter.
This combination of macro and micro headwinds has killed the sector.
Overall, then, ACB stock got really hot in early 2019 because of plunging rates and improving fundamentals and has since cooled off dramatically because of rising trade tensions and deteriorating fundamentals.
Why Aurora Stock Could Reverse Course in a Big Way
Aurora stock looks positioned for a big breakout into the end of 2019 for three simple reasons.
First, macro market conditions will improve. Stocks are in free-fall right now because rates are not getting cut like the market wants them to get cut, and because the trade war is heating up. But, the reality is that U.S. President Donald Trump wants lower rates. So, he upped the ante in the trade war to get those lower rates.
In response, the Fed will cut rates. Trump will be happy about the rate cut, so he will pull back on the tariffs. Thus, by the end of 2019, we will have a stock market defined by fewer tariffs and lower rates; a recipe for higher stock prices.
With respect to the cannabis market, we are already seeing improving results. After sequential sales declines in January and February, the Canadian cannabis market has posted positive sequential growth in March, April, and May.
Not surprisingly, the only cannabis company that has reported results for the three months ended in May, Aphria, reported really good numbers and APHA stock soared. Other cannabis companies, Aurora included, are positioned to report similarly strong numbers in their next print. Further, the launch of cannabis 2.0 products at the end of 2019, like vapes and edibles, will provide a big tailwind for sales and margins.
With respect to ACB stock specifically, you have a relatively undervalued asset that will roar higher once the pot sector bounces back, much like it did in early 2019.
On a volume basis, the three other big 4 pot stocks are being valued at between $1 million and $4 million per kilogram of cannabis sold last quarter. ACB stock is being valued at just $700,000 per kilogram of cannabis sold last quarter. The same valuation discrepancy exists on a forward sales basis. ACB stock trades at less than 7-times forward EV-to-sales. The other big 4 pot stocks trade north of 8-times forward EV-to-sales.
Bottom Line on Aurora Stock
It’s been a tough and volatile ride in ACB stock. But, that’s what you sign up for when you buy a pot stock: a lot of volatility characterized by multiple big drops and multiple big rallies. The rationale is that, at the end of it all, the big rallies will outweigh the big drops, and the stock will end up significantly higher in a decade.
That story remains in-tact for ACB stock. As such, current weakness seems like a precursor to a big recovery rally. I’m a buyer ahead of what should be a big rally by the end of 2019.
As of this writing, Luke Lango was long CGC and ACB.
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