The hits keep on coming for Aurora Cannabis (NYSE:ACB) stock. Amid earnings disappointments, management changes and sector pressure, Aurora stock continues to slide, reaching its lowest point in over two years this week.
There’s a case to be made that the declines will end at some point. Balance sheet concerns are real but as I detailed last month, bankruptcy is an unlikely near-term outcome. ACB stock isn’t “cheap,” even below $2: considering Aurora Cannabis’s debt and a market capitalization that’s still near $2 billion, it trades at more than seven times its fiscal 2020 revenue estimates. But there’s a huge opportunity for cannabis plays across the board, with regulatory improvements and “Cannabis 2.0” likely to boost demand in the Canadian market.
And of course, the U.S. market looms. The Canadian market is attractive, and Aurora has operations around the world, but it’s U.S. consumers who could really move the needle for ACB stock, and for the cannabis sector as a whole.
Federal legalization of cannabis seems likely at some point in the future, given steady progress at the state level. A regulated national market in the U.S. would support years, if not decades, of growth for the likes of Aurora, and justify what still look like reasonably high valuations across the sector.
But it’s becoming increasingly clear that Aurora Cannabis stock is not the play for investors bullish on the U.S. cannabis opportunity — particularly not right now. That in turn creates a key question: if Aurora Cannabis isn’t a U.S. play, are other, smaller, markets enough?
The Catalyst Problem for ACB Stock
The first issue with treating Aurora stock as a play on U.S. cannabis is that shifts in federal policy are highly unlikely any time soon. “The biggest legislative changes of 2020 will be the enforcement of existing laws,” cannabis industry attorney Scot C. Crow of Dickinson Wright told InvestorPlace. And the upcoming presidential election will put a hold on any major changes to federal policy on marijuana.
“This will be a year of increased friction and enforcement as federal legislation largely stalls due to the presidential election cycle,” said Crow. “IRS enforcement actions against legitimate state businesses could increase the possibility of meaningful federal action, but not realistically until after the election cycle.”
The SAFE Banking Act, which protects banks working with cannabis companies in states with legalized, regulated cannabis, passed the House of Representatives in November, but Senate passage seems unlikely in 2020, if at all. Instead, it’s possible that the federal-state battle over cannabis will accelerate, according to Crow’s prediction of “increased friction and enforcement” in 2020.
“Federal and state agencies enforcing existing laws will expose non-compliant state operators,” Dickinson Wright Attorney Benton B. Bodamer told InvestorPlace. “Legitimate competition will bring risk of failure in select markets, testing state and federal enforceability of contracts and receivership and bankruptcy protections, even further than last year.”
If anything, state-level markets may look less attractive by the end of this year. We’ve already seen massive oversupply in markets like Oregon. As Bodamer notes, it’s possible that producers will fail in response. Those failures could expose the issues, such as still-patchwork regulation and unsettled contract law, that persist in state-level markets.
On the whole then, the U.S. cannabis market is likely set for a rocky 2020. And so investors buying any cannabis stock based on U.S. opportunities would do well to exercise patience until after the elections at least.
Aurora’s U.S. Exposure
For Aurora Cannabis in particular, the problem is more significant. Right now, the company simply doesn’t have a path to a legitimate presence in the U.S. market.
Aurora does have exposure to the American market in two ways. First, the company has an agreement with Australis Capital (OTCMKTS:AUSAF) to buy a significant stake in Australis in the event of U.S. legalization. Australis was spun out from Aurora in 2019, and primarily works in the U.S. cannabis market, including real estate assets. The existing partnership also suggests Australis could be a customer for Canadian-produced cannabis if U.S. regulations end up allowing for imports.
Second, Aurora has a partnership with the Ultimate Fighting Championship mixed martial arts league to research the effects of cannabidiol (CBD) on athletes. That partnership, as detailed on Aurora’s Q4 conference call, aims to “generate the data required to establish CBD as an accepted therapeutic ingredient.”
Per management, both efforts are part of a broader strategy focused on the U.S.
Aurora Chairman Michael Singer said on the Q1 call that when the U.S. strategy is announced some time in the future, “it’s going to be very clear as to how this ties together.”
The U.S. Problem for ACB Stock
But investors should be highly skeptical of that statement. Aurora Cannabis’s current U.S. presence isn’t nearly enough. And it’s hamstrung in its ability to expand into the U.S. in force.
The two announced U.S. efforts are going to have minimal impact on ACB stock. Aurora’s option on Australis is being affected by that company’s planned merger with privately held Folium Biosciences, a deal that would give Australis just 11% ownership of the combined company. Aurora can only buy a piece of that equity — or a low single-digit percentage of the merged business. Even if Australis and Folium combine to become a game-changer for the U.S. market, Aurora won’t benefit enough to move the needle on ACB stock.
As for the CBD opportunity, a research partnership is nothing close to an actual profit-generating operation. And the U.S. CBD market is a mess, with unclear regulation from the Food and Drug Administration (FDA) and a patchwork of state-level regulations. Even industry leader Charlotte’s Web (OTCMKTS:CWBHF) has seen its stock decline 71% just since Aug. 5.
And even if the market does become clearer, Aurora has no real edge and competition will be intense. Charlotte’s Web, Cronos (NASDAQ:CRON), Canopy Growth (NYSE:CGC) and many others have their eye on the market. It’s asking a lot for Aurora to outperform so many rivals, including companies that have already established supply and distribution chains when Aurora has not.
The Cash Issue
There’s another issue, of course: cash. Again, it doesn’t seem like Aurora is going bankrupt any time soon, but it does need to conserve capital, and a decent chunk of the cash it’s currently holding is going to be burned as the operating business runs at a loss. If Aurora Cannabis wants to enter the U.S. market in earnest, it will either have to spend big and build out its business or acquire an existing operator.
Either option would be difficult, since Aurora just doesn’t have the balance sheet for a big move, and raising more cash will be exceedingly difficult at this point. The company has already significantly diluted shareholders. Quality sellers are not likely to take risky ACB stock if they can get shares of, say, Cronos, still flush with cash from an investment by Altria Group (NYSE:MO).
So it’s quite difficult to see how Aurora Cannabis could enter the U.S. market in force any time soon. It doesn’t have the leeway to make an acquisition, and it may not even have the capital to invest heavily by 2022 or 2024. Its existing domestic market presence is minimal.
That seems like a significant problem for ACB stock going forward, especially when its peers do have U.S. optionality. Most notably, Canopy has a deal with Acreage Holdings (OTCMKTS:ACRGF) to enter the U.S. market in force as soon as federal legalization arrives. Cronos and even Tilray (NASDAQ:TLRY) will have dry powder to make their own moves.
Aurora has no such luxury, with its share price depressed and balance sheet stretched. It will take years to fix both problems. And until then, investors bullish on the U.S. simply need to look elsewhere.
As of this writing, Vince Martin did not hold a position in any of the securities mentioned above.