Following a dismal 2019, many pot stocks including Aurora Cannabis (NYSE:ACB) stock have continued to trade near all-time lows this year, too. So far in 2020, ACB stock is down over 70%, hovering at $7.8. Despite this decline, the daily trading volume of ACB stock remains strong.
Last week saw volatility in broader markets increase and profit-taking kick in. As a result, many stock that have gone up in recent weeks gave back some of their gains. So what should investors in ACB stock do in September? The company is expected to report Q4 FY20 earnings on Sept. 15. If you’re not currently a shareholder, you may want to wait to commit fresh capital into Aurora Cannabis. Analyzing the upcoming results may be more prudent before hitting the “buy” button. Here’s why.
Industry Headwinds Continue
Cannabis stock investors would like to return to the rosy days of 2018. Yet for most popular pot shares, including ACB stock, lasting stability could still be a distant dream.
According to recent research by Oludamola Durodola and Deepika Chotee of Lakeland College, Canada, “11 per cent of Canadian youths and adult consume approximately 700 tons of cannabis annually.” Over the past several years, Canada has had a large number of players enter the legalized marijuana market because of its growth potential.
However, as early as 2019, hope was replaced by reality. Slower than expected growth, regulatory hurdles, and high rates of cash burn have become nightmares for most of these companies. In addition to an oversupply in the market, the relentless strength of the black market is an important issue.
One of the most important points to remember is that cannabis is an agricultural commodity, affected by demand and supply issues. Due to regulatory reasons, these Canada-based pot producers cannot supply to recreational pot users outside Canada — a fact that is not likely to change any time soon. Also, medical cannabis sales worldwide are also limited. Therefore, company valuations should and will ultimately be based on actual demand and supply parameters.
Durodola and Chotee further highlight, “Cannabis stocks on average possess higher level of risk when compared with growth and speculative stocks on the TSX.” In fact, shares on Aurora, one of Canada’s largest producers, is a testament to the volatility in prices.
Aurora Is Not Yet Profitable
How can a producer like Aurora Cannabis maintain high margins in an industry that does not have a meaningful growth potential?
Aurora’s management has set itself a target of margin improvement as well as turning the company EBITDA positive by the end of the year. In 2020, interim CEO Michael Singer put his mark on a number of spending cuts, including lay-offs and decrease in capital spending. Q3 results showed an improved balance sheet compared to the previous quarter.
With some further cost-cutting measures management will possibly come close to becoming EBITDA positive. But becoming profitable could still take many quarters, if not years. Like many other cannabis producers — such as Canopy Growth (NYSE:CGC) or Tilray (NASDAQ:TLRY) — Aurora Cannabis stock has so far not been able to convert the revenue growth into real profits.
Also most pot stocks have been burning through loads of cash and losing money like there’s no tomorrow. The company used 154.5 million CAD in its fiscal third quarter, down from 273 million CAD in the previous quarter. Although it is a considerable YoY improvement, that amount is still high for a company with a market capitalization (cap) of about $900 million. Furthermore, its total debt from borrowing is close to 250 million CAD, another high amount that may mean financial headache in the quarters aheads.
Cash flows are also far from predictable. Price weakness in most pot shares including ACB has improved relative valuations, but these stocks aren’t necessarily cheap yet. Unless Aurora Cannabis stock improves profitability metrics, I’d be skeptical of any up move in price.
The Bottom Line on ACB Stock
2019 and 2020 can be summarized as catastrophic for the price of most cannabis shares including ACB stock. The industry is in now in a multi-year down trend.
Behind the underperformance of Aurora stock over the past two years are important fundamental issues. They include lower-than-expected demand for cannabis-derived products, a strong black market, and high operating losses.
The company is expected report earnings in the coming days. Investors would like to see a stronger balance sheet and fundamental metrics that would give inspire confidence in management’s long-term ability to operate as an efficient entity. Otherwise, they may continue to hit the sell button.
I’d not yet be willing to buy ACB stock. On a final note, 2021 may become the year of industry-wide mergers and acquisitions in the cannabis space. If Aurora becomes a target for acquisition, then shareholders could be well rewarded.
On the date of publication, Tezcan Gecgil did not hold (either directly or indirectly) any positions in the securities mentioned in this article.
The author has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. She also publishes educational articles on long-term investing.