Cannabis stocks like Aurora Cannabis (NYSE:ACB) are starting to stabilize. Aurora stock has bounced over 40% from last month’s lows, and has managed to hold early December lows. Canopy Growth (NYSE:CGC), still the sector’s most valuable play, has rallied over 50% since selling off following earnings in November.
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To be sure, pot stocks still sit well below past highs, and it’s possible recent trading is a so-called “dead cat bounce.” But at the least sentiment toward the sector doesn’t seem quite as negative as it was just a few months ago. Expectations may be more reasonable, with a better understanding that the Canadian market alone can’t drive the upside investors modeled in at the highs.
The problem for Aurora stock is even that outlook isn’t quite bright enough. A slow, measured recovery simply may not come quickly enough — and likely would be more beneficial for other major cannabis companies. The case for buying ACB stock at this point, and choosing it over other cannabis plays, requires a much steeper recovery in sentiment and in sales. And I’m skeptical a recovery of that kind is on the way.
Are Cannabis Stocks Bottoming?
Again, there is at least a hint of optimism toward the cannabis sector at the moment. The relentless pot stock selloff that began last spring has ended. Executive and investor focus has turned away from plunging production margins to “Cannabis 2.0” products like vapes and edibles. The regulatory backlog at Health Canada is starting to ease.
2020 should at worst be a better year for the industry, and its stocks, even if that admittedly is a low bar to clear. Looking further out, the long-term opportunity remains expansive. Legalization at the federal level in the U.S. could arrive at some point. Aurora Cannabis itself has an extensive international reach.
To be sure, risks remain. Valuations in the sector may be cheaper — but they’re not cheap. Cannabis companies as a whole still have tens of billions in combined market capitalization. Price-to-revenue multiples remain dear: ACB stock, including debt, trades around 5x the fiscal 2021 consensus revenue estimate.
Still, there’s a sense both in the stock market and in listening to cannabis executives that normalcy has returned. Investors aren’t expecting cannabis names to triple in a matter of months. Executives are adapting to the new reality on the ground: Tilray (NASDAQ:TLRY) even announced layoffs this week. A recovery, if it comes, will take some time, but industry participants at least have hope for a recovery after a difficult 2019.
The Problem for Aurora Stock
The catch for Aurora stock, however, is that hopes for a modest recovery simply aren’t good enough. This still is a company with significant balance sheet questions. And though I’ve argued that dilution, not bankruptcy, is the key risk, Aurora will need capital to get by in a slow-recovery scenario. That probably suggests more share issuances — and further pressure on the ACB stock price.
Meanwhile, rivals have that capital — and plenty of it. Canopy raised billions from Constellation Brands (NYSE:STZ,NYSE:STZ.B), and Cronos (NASDAQ:CRON) received a huge infusion from Altria (NYSE:MO).
In a scenario where cannabis revenues grow at a reasonable pace, and profitability is a few years out, those majors have the edge. Their capital may allow them to buy assets of smaller distressed or bankrupt producers. Instead of focusing on cost-cutting, Canopy and Cronos can ramp marketing spending to capture share in higher-margin branded products. Capital allows for flexibility — and flexibility will be valuable in a market that takes years to develop.
The Case for ACB
There is one case for Aurora stock, however. In an environment where cannabis sales, and cannabis stocks, soar, ACB is the play.
After all, that leveraged balance sheet amplifies both downside and upside. Aurora’s debt is a key reason why Aurora shares have fallen even further than those of most peers. But in an upside scenario, ACB stock should outperform.
A similar dynamic applies to Aurora’s business. Few companies have Aurora’s existing reach. If sales suddenly take off — in the recreational market in Canada or in medical markets overseas — Aurora is best-positioned to capitalize.
For those investors still hugely bullish on cannabis — and bullish on the near-term opportunity in particular — Aurora stock is the right choice. A rally in its stock can ease financing worries. A spike in Canadian demand will improve margins and get the company closer to profitability quicker. At this point, that’s the only case left. Personally, I don’t think it’s near enough.
As of this writing, Vince Martin has no positions in any securities mentioned.
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