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Meet Aurora Cannabis’ (ACB) New Bear

With a $5.25 billion market capitalization, Aurora Cannabis (ACB) is the second most highly-valued cannabis stock on the market (after Canopy Growth). It's also the most polarizing name among cannabis analysts, garnering 4 'buy,' 5 'hold,' and two 'sell' ratings in the past 3 months.

On Thursday, MKM Partners analyst Bill Kirk initiated coverage on Aurora stock and told investors to sell it.

What provoked the analyst to make this move? "We believe profitability for cultivators [such as Aurora Cannabis] will generally get worse before getting better. Pricing is already decreasing and supply availability will continue to grow/improve." And as any Econ 101 student can tell you, given constant demand, any increase in supply tends to push prices (and profits) down.

Supporting the theory, Kirk observes that already, "most new markets have shown decreasing profitability for cultivation." (In Colorado for instance, one of the first states to "legalize" in the U.S., wholesale marijuana flower prices are said to have dropped by half in their first few years of legalization -- from $2,000 per pound in 2016 to $1,000 more recently). Despite this fact, most analysts following Aurora stock, notes Kirk, are projecting unprecedented levels of growth for Aurora Cannabis -- and in this case, "unprecedented" can be best defined as "historically unlikely."

Whereas Kirk notes that consensus expectations call for Aurora to swing from negative C$157 million in profit in 2019 to positive C$241 million in 2021, the analyst predicts profitability will be much longer in coming. He projected negative earnings before interest and taxes of C$314 million this year, for example, followed by negative C$265 million in 2020, negative C$199 million -- indeed, no operating profit whatsoever before 2024 at the earliest. (And no free cash flow before 2025).

And the story gets worse.

As investors have soured on the marijuana story, resulting in "industry equity declines," Aurora's stock price has suffered greatly -- falling by nearly 45% over the past 12 months. This lower stock price could "cause more difficulty [for Aurora] refinancing some convertible notes coming due (March 2020)." Investors who might have happily offered Aurora money in exchange for the chance to later trade in their loan demands for shares of an increasingly higher-priced Aurora stock, will be less enthusiastic about the prospect of getting to buy into a stock that's steadily losing value.

Without the ability to fund itself by issuing convertible debt, Aurora "will have to go back to the capital markets [seeking more traditional loans] at a time when profitability still hasn't been reached." Such loans could be harder to come by with Aurora looking like more of a credit risk. And even if the company can convince banks to loan it money, they will probably demand higher interest rates, further weighing on the company's ability to turn a profit.

Taking a cue from these hypothetical lenders, Kirk is going ahead and rating Aurora Cannabis stock a "sell" itself, and predicting the shares will hit C$5 within a year. (See Aurora's price targets and analyst ratings on TipRanks)