Four Reasons to Avoid Aurora Cannabis Stock at the Lows

With ACB stock down by two-thirds, investors might be tempted to time the bottom. Here's why they shouldn't.

For investors willing to time the bottom in cannabis stocks, Aurora Cannabis (NYSE:ACB) is an intriguing choice. No other pot company has the company’s breadth in terms of global reach and product portfolio. Aurora Cannabis stock isn’t necessarily cheap, yet. But Aurora stock certainly is cheaper, with a two-thirds decline from March highs to a current two-year low.

Four Reasons to Avoid ACB Stock at the Lows
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Even the ACB stock chart has bottomed, at least in recent sessions. Certainly, some investors see a share price below $4 as an opportunity.

But for several reasons, I’m not one of those investors. Again, the story is intriguing — and it may well work. I argued earlier this year that Aurora Cannabis would be either the biggest winner or the biggest loser among pot stocks. If sentiment toward the industry finally reverses, ACB stock should benefit.

Still, there are significant risks here, and I have become increasingly bearish toward the story in recent months. Those risks need to be kept in mind, and suggest at the least investors should stay on the sidelines.

The Valuation Problem for Aurora Stock

The broadest issue at the moment is that Aurora stock is not cheap. Yes, the stock price has dropped by two-thirds. But Aurora Cannabis infamously has over 1 billion shares outstanding. The company has used its stock to fund the acquisitions that have given it a presence in some 25 countries and both the recreational and medical markets.

At a current price of $3.66 on the New York Stock Exchange, Aurora Cannabis still has a market capitalization near US$4 billion. There’s another US$350 million in debt on the balance sheet net of cash, creating an enterprise value in the US$4.2 billion range.

That figure is roughly 10x its estimated revenue for fiscal 2020. 10x sales obviously is not a cheap multiple, and that’s doubly true given the composition of those sales.

The Cultivation Problem for Aurora Cannabis Stock

One of the bear arguments toward pot stocks even before they boomed was that growing cannabis wasn’t going to be a great business. Farming simply is not a profitable endeavor. Coca-Cola (NYSE:KO) profits dwarf those of the world’s sugar cane (and corn) growers. Growing cannabis, skeptics argued, would be a low-margin, commoditized business.

To be fair, that argument is somewhat simplistic. Cannabis strains create notably different effects on consumers in a way that pure agricultural commodities do not. But the broad point about margins and potential growing profits made some sense.

Aurora, however, has been one of the most aggressive companies in expanding its production capacity, along with Canopy Growth (NYSE:CGC). And that increasingly looks like an errant strategy. Oversupply has become a huge problem in U.S. states like Oregon, and is set to be the same in Canada.

This is a key reason why I’ve thought plays like Cronos (NASDAQ:CRON) and even Tilray (NASDAQ:TLRY) look more intriguing at the lows. Both stocks, like Aurora stock, are obvious falling knives. But both companies have made a point of focusing on branding and derivatives, and are set to benefit from the same plunging prices that will hit Aurora Cannabis margins — and already are pressuring Aurora Cannabis stock.

An Execution Stumble and More Dilution of ACB Stock

Of course, a strategy is only as good as its execution. And here, too, Aurora has a problem.

As I wrote in August, it seemed for a moment as if the news was getting better for Aurora Cannabis. Preliminary results for the fourth quarter impressed. An upsized credit facility limited worries about further dilution. The fear had been that Aurora’s falling share price meant its convertible debt would need to be repaid in cash. Aurora didn’t have that cash, and would need to sell stock. With the larger facility, however, dilution worries appeared assuaged.

Fourth quarter earnings negated both positives. The company missed preliminary guidance; even the company’s chief commercial officer admitted that management was “red-faced.” A revised outlook for fiscal 2020 suggested another year of negative EBITDA (earnings before interest, taxes, depreciation and amortization). That in turn resurrected funding worries.

The impact goes beyond the fundamentals. Again, this is a company whose strategy has been to go full-bore into more markets than anyone else. If management can’t forecast its business, it can’t execute that strategy.

Add these issues up, and the risks are obvious in both the short term and the long term. The threat of dilution could serve as an overhang on ACB stock until clarity appears on the funding front. The strategy looks risky in an industry facing oversupply in Canada and limited recreational movement worldwide. Management erred in judging Q4, and overpromised when it came to 2020 profitability.

Those issues can be fixed, admittedly. Cannabis sales worldwide will grow. It’s possible Aurora Cannabis can turn itself around, and regain credibility with investors. But at the least that process will take time, because Aurora has an awful lot of work to do.

As of this writing, Vince Martin has no positions in any securities mentioned.


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