Just when investors thought it couldn’t get any worse, shares of one of Canada’s largest cannabis producers, Aurora (NYSE:ACB), plunged to multi-year lows on a slew of not-so-great updates from the company.
As of this writing, Aurora stock is down 15% to $1.70. Aurora’s Chief Executive Officer, Terry Booth, is stepping down amid a slew of operational changes, including significant cost reductions via the layoffs of 500 employees (including about 25% of the company’s corporate positions).
Aurora also announced huge asset impairments and credit facility changes, as well as deep cuts to capital expenditure. Management also reported preliminary second quarter numbers, which were awful (sales dropped about 10% from the first quarter), as well as preliminary third quarter guidance, which was also awful (sales are expected to be flat quarter-over-quarter).
In short, things don’t look good for Aurora right now. Demand trends are weak. Sales are dropping. Cash is being burnt, management is in all-out cost-cutting mode and the balance sheet is under pressure.
So investors are throwing in the towel and Aurora stock is tanking.
To be sure, there’s still an opportunity for Aurora to turn things around via cost rationalization and improving Canadian demand trends. In fact, I’m still cautiously optimistic that Aurora stock can explode higher from current levels.
But at this point in time, that bull thesis lacks visibility. Until clarity and stability are injected into the growth narrative, the best place to hangout is on the sidelines.
Lots of Changes
One thing is for sure: lots of changes are happening at Aurora, and the Aurora of 2020 will look almost nothing like the Aurora of 2019.
In 2019, Aurora was in “spend at all costs to grow” mode as they positioned their business for what management thought would be explosive growth. They aggressively tapped into the debt markets to expand production capacity, spend an arm and a leg on sales and marketing, and increase their payroll, all in anticipation of huge demand growth in Canada’s legal cannabis market.
But that huge growth never showed up. Or, it did, but only for a few quarters. Then demand trends in Canada stalled out for various reasons, growth dried up, and Aurora was left with a ton of unsold weed, a bunch of overproducing growing centers, a hefty operating expense base and an over-levered balance sheet.
In 2020, Aurora is trying to reset its business for more moderate growth expectations. They’re gutting the expense model through more focused investment and huge payroll reductions. They’re rolling back on production capacity expansion. They’ve restructured their credit facility and tried to shore up the balance sheet.
Some of these changes are good. Lower operating and capital expenses should translate into improved profitability and healthier cash flows. But some of these changes are bad, because they are a recognition that Aurora isn’t growing like it was supposed to. Indeed, it’s hardly growing at all anymore, with second quarter sales down 10% from the first quarter and third quarter sales guided to be flat sequentially.
What’s Next for Aurora Stock
At this point in time, Aurora stock looks like a case of near-term pain and long-term gain.
In the near-term, there’s simply too much instability and too little visibility to warrant anything other than prolonged weakness in the stock. Investors won’t buy the dip here until management shows that they can stabilize sales while gutting the expense base, and management won’t be able to prove that with numbers for another few months. Until then investors will remain dubious and the stock will remain weak.
But in the long-term, I’m cautiously optimistic that Aurora stock can explode higher.
Why? Because over the next few quarters, I see Aurora’s sales moving higher, its expenses moving lower, and its losses significantly narrowing — a dynamic which should shoot the stock higher.
In short, Canadian cannabis demand trends will improve in 2020 thanks to a ton of retail store openings and new edibles, drinks, and vapes product launches. This will provide a boost to Aurora’s presently depressed sales trends. Concurrently, Aurora will remain focused on gutting the expense model, so the opex base will drop significantly. Rising revenues plus falling expenses equals narrowing losses. Narrowing losses should be enough to push Aurora stock way higher from here.
Bottom Line
In the long run, I still think Aurora stock can run way higher. But recently announced changes imply that things will get worse before they get better.
So it’s best to remain on the sidelines for now. Let all these changes create a ton of uncertainty, and let than uncertainty weigh on the stock. Then, if demand trends start to pick up later this year and expenses start to fall, buy the stock. That’s when shares will start moving higher.
Until then, don’t try to catch this falling knife.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
