In my Oct. 21 column, I warned readers that the worst was yet to come for Aurora Cannabis (NYSE: ACB) stock. With ACB stock down 40% in the two months before that piece was published, it may have seemed bold at the time. However, in just over a month since I wrote that article, Aurora stock has tumbled another 31.7%.
Aurora’s balance sheet and cash flow situation will stay ugly in the near-term. But I still think Aurora stock can eventually become a viable, long-term investment.
Worse-than-expected third-quarter numbers and a surprise early conversion of $171 million of bonds has sent ACB stock tumbling once again. The 7% shareholder dilution associated with this conversion at a 3.28 CAD ($2.46) price is exactly the type of semi-desperate action Aurora will have to take to keep its business going until its fundamentals improve.
Today I want to focus on the signs that will indicate that it may be finally time to buy ACB stock. Here are five things Aurora needs to do to win back investors’ trust, according to Cantor Fitzgerald analyst Pablo Zuanic.
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Issue Honest Guidance
It may seem tempting to provide ambitious guidance to please investors in the near-term. But if companies consistently fail to deliver on that guidance, they are doing nothing more than creating a reputation for constant disappointment. Zuanic says the $107 million Aurora raised from equity financing in October and the $216 million it has raised from bond conversions will be used up by the end of Q1 of 2020 unless the company’s cash-burn rate drops. Management needs to either clearly outline its long-term financing plan or clearly discuss spending cuts because one of the two will be critical within the next six months.
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Demonstrate a Path to Profitability
Profitability will eventually be key for all marijuana stocks. But Aurora stock has been especially plagued by ACB’s cash burn and equity dilution. The company said it would reach positive earnings before interest, taxes depreciation and amortization (EBITDA) in the quarter that ended in June. It didn’t hit its target. EBITDA margins took a bit step back in the September quarter, dropping from -12% of the company’s sales to -56% of its sales.
“Even if some of this relates to one-off factors…, more clear guidance is required given the circumstances and even perhaps cost cuts,” Zuanic says.
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Taper Down the Stock Compensation
The amount of Aurora stock that the company uses to pay employees is unreal. Share-based comp was 33% of sales in the September quarter and averaged 43% of sales over the previous fiscal year. For perspective, OrganiGram’s (NASDAQ: OGI) stock-based compensation was only 8% of its sales last quarter. Aphria’s (NYSE: APHA) stock-based compensation was just 4% of its sales in Q3.
Diluting shareholders to raise capital to grow the business is bad enough. Diluting shareholders to line the pockets of management adds insult to injury. Zuanic says management should make a gesture of good faith and freeze share-based compensation for one year until the company’s fundamentals improve.
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Scrap the CBD Business
When times get tough, companies have to make tough decisions. Aurora’s balance sheet is clearly spread dangerously thin. Zuanic says the company needs to focus on its core business. In fact, he says Aurora needs to drop its U.S. cannabidiol (CBD) strategy all together. It’s unclear just how much time, money and resources Aurora has been devoting to the CBD business. But it seems unlikely at this point that it will end up being a market share leader in the U.S. CBD market.
“The market is overcrowded with a plethora of brands and future growth is now being questioned without clear FDA guidelines,” Zuanic says.
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Focus On Canada
One year after Canada legalized recreational cannabis smoking, the nation recently legalized derivatives such as cannabis edibles and beverages. Zuanic says there will certainly be growth opportunities for cannabis companies in Europe.
But Aurora needs to maintain and/or grow its market share in its core Canadian market in the near-term. Domestic medicinal cannabis still represents 36% of Aurora’s total cannabis revenues. By continuing to milk the medicinal market, growing its market share in the recreational market and establishing a strong footprint in edibles, Aurora has all the near-term opportunities it needs right in its Canadian back yard, according to the analyst.
How to Play Aurora Stock
Unfortunately, little has changed about Aurora’s near-term outlook since I wrote my last article a month ago. I still see ACB stock as a show-me story and would recommend that investors stay on the sidelines until management proves it can get the company back on the right track.
Zuanic is a bit more optimistic and says patient investors can co ahead and buy Aurora stock on weakness at this point. Cantor Fitzgerald has an “overweight” rating and a 3.11 CAD ($2.34) price target on Aurora Cannabis stock.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.
