Back in January, I cautioned investors that it was still too early to safely buy Aurora Cannabis (NYSE:ACB) stock. In the roughly three weeks since that story was published, Aurora stock is down another 23.4%. In that time, Aurora announced a major management change, debt restructuring and cost-cutting initiative.
Aurora is releasing its fiscal second-quarter earnings on Thursday morning.
Unfortunately for Aurora, there are still much safer bets in the high-risk cannabis space at this point.
On Feb. 6, one week ahead of its earnings report, Aurora made a much-needed strategy reset. The first big piece of news was the departure of its founder and CEO Terry Booth. Given the company’s struggles in recent quarters, Booth getting the boot wasn’t necessarily a surprise.
For now, executive chairman Michael Singer will take over as interim CEO. But Aurora should be looking to bring on a well-respected permanent CEO with a long-term track record of success. That success should preferably come from outside of the cannabis industry, in my opinion.
The second part of Aurora’s big update was a new cost-cutting plan that involves 500 layoffs, about 15% of the company’s total workforce. Aurora said it aims to reduce its selling, general and administrative expenses from 59 million CAD in the first quarter to between 40 million CAD and 45 million CAD.
Third, Aurora is taking impairment charges of between 190 million CAD and 225 million CAD and goodwill charges of between 740 million CAD and 775 million CAD in the second quarter. This write-down is also not surprising given the values of the companies it has acquired have plummeted in the past year.
Last but not least, Aurora restructured its secured credit facilities to give itself some financial breathing room. The company adjusted covenants requiring it to have a total funded debt-to-adjusted shareholders equity ratio at or below 0.25:1 by Sep. 30, 2020. That ratio has now dropped to 0.20:1.
Aurora also reduced the total size of its credit facility by 141.5 million CAD and removed all covenants tied to earnings before interest, taxes depreciation and amortization (EBITDA) ratios. Instead, the updated facility covenants require Aurora to reach positive EBITDA by the fiscal first quarter of 2021.
Is It Enough?
First of all, the financial restructuring was much-needed, long overdue and a step in the right direction. Unfortunately, Bank of America analyst Christopher Carey says market expectations are still too high.
“Covenants have been extended, but now require C$50mn EBITDA in FY21, with positive EBITDA each FY21 qtr, and never less than C$35mn in cash (despite ‘the market taking a hard turn to value segment’ which could pressure ACB margins further). Big picture: we think more cuts may be needed,” Carey says.
GLJ Research analyst Gordon Johnson says Aurora may simply run out of cash by the end of the year.
“When dividing by ACB’s current daily cash burn rate of -CAD$2.16mn/day, we calculate just 211.8 days of total liquidity left for ACB, suggesting the company may need to file for [bankruptcy] protection at some point in C3Q20,” Johnson says.
To me, Johnson’s “sell” rating and $0 price target are a bit pessimistic. I guess they are literally as pessimistic as you can get. I’m more in-line with Bank of America’s “underperform” rating and 94-cent target. Aurora’s core business has value. I think the company will continue to find funding. But that funding may end up costing Aurora stock investors an arm and a leg along the way.
How To Play Aurora Stock
Aurora stock investors have gotten a lot of good, bad and ugly news in recent weeks. They will certainly get even more on Thursday. However, my fundamental outlook for the stock hasn’t changed.
In a Canadian cannabis environment that has consistently underperformed expectations, companies like Aurora that are struggling with cash flow are fighting an uphill battle. In the long term, I’m sure there will be some huge winners in the cannabis stock group. However, in the near term, Aurora stock is incredibly risky.
Rather than buying a single cannabis stock, I have been recommending investors consider owning a basket of at least four or five cannabis stocks to diversify. At least most of those stocks should be companies with strong balance sheets and/or deep-pocketed minority investors. I recommend Canopy Growth Corp (NYSE: CGC), Tilray (NASDAQ: TLRY) and Cronos Group (NASDAQ: CRON).
For now, Aurora may not be headed for bankruptcy. But that doesn’t mean there won’t be more pain ahead.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.