Over the long run, I still believe cannabis will be a wonderful business for investors. But I don’t believe Aurora Cannabis (NYSE:ACB) is the play. Aurora stock simply has too many near-term risks.
To be sure, ACB has rallied of late along with the sector. Aurora stock has bounced 50% from its lows. The ETFMG Alternative Harvest ETF (NYSEARCA:MJ), which I like to use as a proxy for investor sentiment toward cannabis, has bounced only about 29%.
Of course, ACB had underperformed even as cannabis stocks fell amid this broad market sell-off. And I believe, as I wrote back in February, that it will underperform going forward.
Aurora Cannabis simply has spent too much money on too many acquisitions. It’s spread too thin. Even former chief executive officer Terry Booth seems to know as much: he dumped over 12 million shares last month.
Investors should follow him out: there simply are better plays elsewhere in the sector. The challenges that Aurora Cannabis is going to face are going to be severe. And they’re highlighted by a few recent developments elsewhere in the industry.
What Hexo Earnings Mean for Aurora
There were two aspects of the report that worried investors. First, Hexo impaired the intangible assets picked up in its acquisition of Newstrike Brands last year. And second, management admitted that it needed to raise more capital — after raising over $100 million between October and January.
Both developments highlight the near-term problems for Aurora going forward. Aurora of course reported a loss of 1.3 billion CAD in its fiscal Q2, thanks to its own impairments. Hexo’s report shows that more such writedowns may be on the way.
At the very least, Hexo’s writedown further highlights the problem in this industry: too many companies paid too much for too many assets, particularly in terms of production. Aurora Cannabis may be the biggest offender.
It’s the need for capital, however, that is more concerning for Aurora.
The Cash Problem
At the end of its fiscal second quarter, Aurora had almost $500 million in debt. It’s still burning cash as well.
Aurora is slashing costs in a bid to get to free cash flow quicker. But cost-cutting probably isn’t enough. Aurora needs to raise capital.
The debt markets at this point are closed. Aurora’s convertible bonds due 2024 trade at 53 cents on the dollar. Those bonds yield 24%. Aurora can’t add new debt at any logical interest rate.
That means the company has to sell stock. And that makes the lower Aurora stock price a problem. There are over a billion shares outstanding, so Aurora probably can raise a decent amount of funds through an equity offering. But such an offering would only depress the share price further.
But if Hexo is selling stock, there’s even more pressure to attract the institutions needed to buy those offerings. And it’s not just Hexo. Tilray (NASDAQ:TLRY) just priced an offering at an enormous discount. TLRY stock fell over 30%.
Better Options Than Aurora Stock
Again, I believe cannabis provides an enormous opportunity for long-term investors. And I believe the decline in the sector over the last year has made that opportunity even more attractive.
But just because the opportunity for the industry is enormous doesn’t mean every cannabis stock is a buy. The short-term challenges are real. Regulator Health Canada has been slow to approve retail locations. The novel coronavirus pandemic adds another source of near-term pressure.
Some companies already have gone bankrupt. Others are going to follow.
Aurora may be one of those companies. But even if it isn’t, it’s not going to be one of the companies that can capitalize on the industry shakeout.
Investors should focus on those that can. Two of the most obvious names are Canopy Growth (NYSE:CGC) and Cronos (NASDAQ:CRON). Both stocks are part of our Cannabis Cash Weekly portfolio because they have fortress balance sheets.
Those balance sheets serve two purposes. They significantly lessen near-term risk, but they also position those companies to pick up production assets, brands, and intellectual property on the cheap from companies that overspent.
Whatever happens with Aurora, it simply won’t have that opportunity. Instead, it’s going to have to navigate a challenging environment for some time to come. Investors who believe in the opportunity in cannabis, as I do, should focus on those companies that can best take advantage.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.