The fairy-tale 2019 for Aurora Cannabis (NYSE: ACB) stock appears to be over. ACB stock roughly doubled in the first three months of the year. It’s now down 22% in the past three months. On Thursday, the slide was capped off by a downgrade from Bank of America.
At this point, ACB stock is a risky bet, given the company’s clear, near-term issues. However, there are potential solutions for ACB down the road. In fact, Aurora may still have an important role to play in long-term cannabis portfolios.
Aurora’s Cash Burn Problem
The primary concern for Bank of America analyst Christopher Carey was Aurora’s cash burn rate. In his note, Carey said Aurora has a strong core-cannabis business. Unfortunately, investors have very little clarity on its balance sheet. For marijuana stocks, clarity and transparency are extremely important.
Like other cannabis producers, Aurora has been spending money like crazy to scale up its production and expand its business. As of the first quarter of 2019, the company had a cash balance of C$390 million. In that same quarter, Aurora burned through C$151 million of cash as its capital expenditures ramped up. If the company stays on its current trajectory, it will need more funding within the next few quarters, Carey says.
To make matters worse, Aurora has a C$230 million convertible debenture that expires in Q1 of 2020 at a share price about 35% above the current level of ACB stock In other words, unless Aurora stock rallies tremendously in the next couple of quarters, Aurora will be on the hook for a C$230 million cash payment in roughly six months.
Raising capital isn’t necessarily a bad thing. But Bank of America’s Carey says raising capital from a position of weakness is always bad news for investors.
“We think ACB’s U.S. expansion (a core strategy, per mgmt) could, if debt is added and no partner found, require other uses of financing like equity (capital raises or deals), despite management’s stated plan to slow pace of equity dilution,” Carey says.
Despite Carey moving to the sidelines on ACB stock, he touches on one obvious near-term solution to all of Aurora’s major problems.: the company needs a powerful partner.
Constellation Brands (NYSE: STZ) has invested $4 billion in Canopy Growth Corp (NYSE: CGC). Tobacco giant Altria Group (NYSE: MO) has invested $1.4 billion in Cronos (NASDAQ: CRON). Tilray (NASDAQ: TLRY) has formed a $100 million partnership with Anheuser-Busch Inbev (NYSE: BUD). In fact, alcohol and tobacco companies were responsible for roughly a third of the $15 billion of total cannabis M&A in 2018.
Analysts have long speculated that Aurora needs a partner with a global brand, copious resources and distribution infrastructure. Aurora even hired billionaire hedge fund manager Nelson Peltz as a strategic advisor earlier this year. Many owners of Aurora Cannabis stock are hoping Peltz will ultimately land Aurora a major partnership.
If Peltz and Aurora are able to secure a partnership with a company like Philip Morris (NYSE: PM), Coca-Cola (NYSE: KO) or Heineken (OTC: HEINY), most of Aurora’s problems would be solved overnight. A partner with similar resources to those firms would enable Aurora to grow into a global giant. ACB stock would also likely get a huge pop as soon as news of such a deal hit the press.
How to Play ACB Stock
Dealing with Aurora Cannabis stock is tricky at this point As Bank of America’s Carey said, there’s nothing wrong with Aurora’s core business. But the company’s balance sheet is a mess. Carey predicts that Aurora will have $200 million of sales in 2019. With a market cap of more than $7 billion, Aurora Cannabis stock is priced at about 35 times the company’s trailing sales. Bank of America doesn’t expect the company to become profitable until next year. ACB stock is already priced for extreme growth, leaving little room for disappointment.
Aurora has plenty of uncertainty at the moment, but it’s not alone. Most of the top marijuana stocks are priced for extreme growth. Yet investors have no idea what the cannabis market will look like in five years.
I think that those who are bullish on marijuana stocks should bet on the cannabis industry, instead of trying to pick individual winners. Inevitably, one or two companies will likely take over the lion’s share of the market. At this point, it’s nearly impossible to tell which companies that will be
Investors can pick ACB stock as the winner and then lose sleep over its high cash burn and balance sheet. Or they can buy shares of Canopy, Tilray, Cronos, Aphria (NYSE: APHA), Curaleaf (OTC: CURLF) and others and assume the long-term winners will come from within that group.
Diversification is that best tool for combating risk. Cannabis bulls shouldn’t stress over near-term volatility. Buy a basket of cannabis stocks and evaluate them in five years.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.