Aurora Cannabis Stock Is the Bitcoin of Equity Markets

In terms of volatility, Aurora Cannabis (NYSE:ACB) stock seems like the bitcoin of equity markets.

Aurora Cannabis Stock Is the Bitcoin of Equity Markets
Source: Shutterstock

ACB stock was trading at $6.19 on Jan. 24, 2019. It subsequently surged by 61% to $9.96 by the third week of March 2019. Renewed selling pressure has pushed Aurora Cannabis stock lower by 32% to current levels of $6.77.

Consider the following points about the company and industry — the estimated global market size for cannabis is $200 billion and Aurora Cannabis plans to go global. Aurora will ramp-up production to 625,000Kg/year in 2020 from production of 150,000Kg/year in early 2019.

It leaves me wondering why Aurora Cannabis stock has failed to trend higher. ACB shares trade at almost the same level as it was in July 2018.

Well, there are undercurrents of concern amidst bright headline factors. This article will discuss some factors that make Aurora Cannabis stock less attractive than it seems.

The Inventory Build-Up

The cannabis demand and supply report by the Government of Canada clearly indicates significant build-up of dried cannabis. Unfinished inventory has increased from 96,822Kg in October 2018 to 183,785Kg in April 2019. It is also important to note that sales have grown at a relatively moderate pace.

From the company’s perspective, the trend in selling price of dried cannabis is indicative of the inventory build-up. The average selling price of dried cannabis was $8.02/Kg for 4Q18. After increasing to $8.39/Kg in 1Q19, the price declined to $6.23/Kg in 2Q19 and $5.86/Kg in 3Q19.

Clearly, the trend is downward and I expect prices to trend lower as inventory remains robust. Even at company level, the biological inventory was C$28.4 million in 3Q18 and it has increased to C$118.0 million in 3Q19.

The following point from the Government of Canada might also provide some insight on the sales and inventory build-up trend:

“On October 17, 2018, the Government launched a national Cannabis Tracking System to prevent legal cannabis from being diverted to the illegal market and to keep illegal cannabis out of the legal market. Federal license holders and provincial and territorial public bodies are required to report information to Health Canada on a monthly basis through a web-based application.”

The point I am trying to make here is that cannabis is potentially sold in illegal markets at a lower price and this adds to the pricing pressure for listed companies.

Positives Discounted In Valuations

Aurora Cannabis commands a market capitalization of $6.8 billion and I believe that current valuations have discounted potential positive triggers.

The reason for this view is the fact that Aurora Cannabis has not even generated profits at operating level (adjusted EBITDA level). It is also worth noting that the company’s debt is increasing and operating cash flow remains negative. With likely pressure on margins (reduced selling price of dry cannabis), the EBITDA and cash flow will remain negative.

The question: Where exactly the $6.8 billion valuation coming from?

The answer is the potential market size of $200 billion that I mentioned earlier.

In addition, the company’s focus on the medical industry has driven valuations higher. The company expects to garner higher margin from medical as well as other premium consumer products.

While industry growth can gain traction in the coming years, the following points are worth noting –

First, Aurora Cannabis reported medical division revenue of C$25.1 million for 3Q19, which was 8% higher than 2Q19 revenue of C$23.1 million. Sequential revenue growth has therefore been moderate.

Second, international medical revenue was C$4.0 million in 3Q19 as compared to C$2.9 million in 2Q19. Therefore, international revenue from the medical segment is small. Importantly, regulatory headwinds are likely to be significant. It remains to be seen if international markets gain traction in the coming years.

The key point: The medical division can possibly prop margins. But it is unlikely that the scale-up will happen soon. What’s more, cash burn is likely to sustain.

Bottom Line on Aurora Cannabis Stock

Medical products and other value-added edible products provide scope for EBITDA margin expansion. Growth in international markets can help Aurora Cannabis sustain revenue growth. In addition to the current focus on Europe, Asia also provides immense opportunity in the long term.

However, uncertainties prevail in the near term. The big surge in unfinished inventory of dry cannabis in Canada is already an indication of intense competition in a market that promises to deliver value in the coming years.

For the coming quarters, I remain bearish on Aurora Cannabis stock, as the valuations still appear stretched. Further, ACB needs to justify its valuation through sustained growth and show a profit at EBITDA level.

As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

©2021 InvestorPlace Media, LLC