Aurora Cannabis (NYSE:ACB) gained approximately 125% over the last month, as markets reacted positively to its earnings report and expansion strategies. However, despite the optimism surrounding Aurora stock, I continue to believe the company suffers from deep-seated issues that hinder its growth and progress.
Although the company managed to drop a better-than-expected earnings report on May 15, I still believe positive EBITDA numbers remain a pipe dream at this point. The onset of the novel coronavirus pandemic led to panic buying, leading to abnormally high sales numbers. I don’t think we will see a repeat in the forthcoming quarters.
Meanwhile, Aurora still needs to keep cutting costs and decrease reliance on debt. It also needs to be mindful that further dilution in existing shareholding will send its stock price into a tailspin.
In addition, even though Aurora bought into the U.S. market through acquiring Reliva, the company remains well-entrenched in the troubled Canadian cannabis market. All of these factors lead me to believe that the Edmonton-based Cannabis producer is still not out of the woods. That’s why a buy recommendation at this point is not prudent.
Earnings Provided a Much-Needed Boon
Aurora stock recorded earnings of 98 cents per share in the recent quarter, missing analyst estimates by 43 cents. However, that was not the headline coming out of earnings seasons, as several metrics inched northward at the end of the quarter. For example, revenues came in at $53.81 million, rising nearly 25% sequentially and beating analyst estimates by $6.81 million.
But as I mentioned earlier, the virus boosted sales in this quarter to unprecedented levels. This may not be the case from here on in, and we might see numbers return to pre-pandemic levels in subsequent quarters.
Interestingly, the gross margin for the company came in at 36.29%, a sharp drop from the quarter ago figure of 53.39% and the year-ago figure of 80.78%. This primarily has to do with the launch of the “Daily Special” product – a competitively priced value brand aimed to combat black market products. Unfortunately, due to the low price, the product’s sales are eating into the company’s gross margin.
However, I do understand Aurora’s predicament in this case. Canada’s licensed producers have to incur substantial legal costs that the black market bypasses. As a result, a gram of recreational cannabis sold by these brands is more expensive than the ones you can find on the street.
That’s why companies like Aurora have to come up with affordable product lines to make sure they remain competitive in the market.
Liquidity Is Still a Burning Issue
An important theme I explored in my last article on Aurora stock was liquidity. I spoke about how it was the key to the company’s future, and I still believe that.
At the end of the first quarter, long-term obligations sit at $386.15 million, an 18.97% increase over the year-ago period. That’s not a great sign considering free cash flows continue to be negative.
This is hardly news, as nearly every major Canadian LP is in the red at this point. The major talking point is whether liquidity will worsen or get better as the year progresses. I am afraid I will have to go with the former here.
The surge in first-quarter sales may not last for the rest of 2020, stressing cash flows further. Operational cash outflow did fall by 60% in the recently concluded quarter, but I believe this is a blip. However, the company’s aggressive cost-cutting initiatives and reduced capital expenditures may help in sustaining this position.
Still, I do not think the company’s promise of delivering positive adjusted-EBITDA by its fiscal 2021 first quarter will materialize. Estimates indicate revenues will rise, albeit at a slow pace. If revenues stagnate while operational and capital expenses rise, where will the company find funds?
Tapping the Equity Markets Will Slow Momentum
Aurora has gone an interesting route when it comes to raising cash. Instead of relying more on debt, the company has chosen to focus its energies on equity. Whenever it’s faced with a shortage of funds, Aurora taps the equity markets with a new share issue, much to the chagrin of existing stockholders.
Some of its stock issues have are bourne out of necessity rather than its desire – the recent 1-for-12 reverse split ensured that ACB stock was not delisted from the New York Stock Exchange and the Toronto Stock Exchange. But most of its stock issuances underline a preference for equity versus debt.
Shareholders are rightly aggrieved, and the markets react negatively each time the company goes down this route. However, with the board recently approving a plan to sell $350 million in new stock under an at-the-market program, I don’t foresee a change in strategy any time soon.
Reliva Purchase Is an Interesting Play
Aurora’s purchase of Reliva for $40 million marks the company’s entry into the U.S. market. Unlike the Canadian cannabis market, the U.S. market is far more competitive and lucrative. It’ll be interesting to see how Aurora can use Reliva’s 20,000 retail locations to make a mark in the local market.
It’s important to note here that the company specializes in topicals rather than medical or recreational cannabis. That means Aurora will have to seek licenses from the U.S. Food and Drug Administration before it can proceed in these areas.
However, we have to give credit where credit is due. The Reliva deal is adjusted EBITDA accretive and adds $14 million to the company’s top line. It also helps the company focus on a market that is set to grow exponentially in comparison to the Canadian industry.
Aurora Stock Is Overvalued
Before the positive earnings report, ACB stock traded at under $6 a pop. As of this writing, ACB shares are trading at $13, so the legroom is diminishing here. Considering the ATM program, I believe the stock will fall further down the year when Aurora decides to drum up cash for its operations.
ACB stock traded at a price-to-earnings ratio of 26.37 times. Now granted that the sector median is 35 times, underscoring how overvalued the Canadian cannabis sector is, it’s still quite astounding to see investors are willing to pay this much for a stock with such murky prospects.
Analyst estimates indicate that we won’t see a positive EPS figure from ACB until 2023, a sobering statistic for all those cheering the company’s revival in recent weeks.
The Final Word on ACB
Aurora’s recent success is built around two developments, a strong first-quarter earnings report and its acquisition of U.S.-based Reliva. However, the company still suffers from long-standing issues that management has yet to address.
Instead of cutting costs more aggressively, the go-to move has been to issue more stock. That’s not a viable long-term strategy. Unfortunately, as I highlighted earlier, the ATM program leads me to believe a course correction is not on the cards.
The last few weeks were great for an ACB stockholder, but don’t expect the fun times to last.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. Faizan does not directly own the securities mentioned above.
