Marijuana stocks like Aurora Cannabis (NYSE:ACB) already were having a terrible year. And then the novel coronavirus hit, pushing things from bad to worse for Aurora stock.
In theory, it shouldn’t have been all bad news. Tobacco and alcohol sales, for example, have been up substantially at both grocery stores and liquor shops. Many states have even declared alcohol to be an essential service, allowing beer and wine stores to remain open.
But marijuana companies are struggling, and Aurora stock continued to fall to multi-year lows.
There’s a simple reason that explains the difference. Tobacco and alcohol are established industries with powerful brands and established buying patterns. Cannabis, by contrast, is an up-and-coming industry. Firms like Aurora are still trying to develop the first-mover advantage. This was the pivotal moment in getting their brands to the top of consumers’ minds and creating durable and profitable distribution channels.
With the coronavirus, many stores are closed or doing much less business. Additionally, permitting and legal processes for new marijuana markets and outlets have ground to a halt. Companies like ACB are losing significant sums of money now, with the intention of making it back later as cannabis matures into a robust market.
But 2020 is shaping up to be a lost year on that front, and it’s put Aurora in a bit of a financial bind. As a result, shareholders are likely to face more setbacks in coming months.
A Reverse Split is Coming for Aurora Stock
In its recent business transformation plan that it laid out with shareholders, Aurora mentioned that it will be engaging in a reverse split next month. On or around May 11, every current 12 shares of Aurora stock will turn into 1 new share of Aurora Cannabis.
If you own 600 shares now, for example, it would turn into 50 new shares. Meanwhile the share price should go up around 12 times as well after the split. So that theoretical 600 share investment would still be worth $450. However, now it will be in the form of 50 shares at $9 each, instead of 600 shares worth 75 cents a pop.
The company is doing this to avoid delisting. If a firm’s stock remains below $1 per share for an extended period, it can be removed from the stock exchange. The reverse split will avoid that, getting the stock price back up to a much higher level.
Drawbacks to the Split
It’s great that Aurora will retain its U.S. stock market listing; that’s a key trait for keeping a solid shareholder base and raising capital. But there are also downsides.
For one thing, share prices usually tend to go down during the reverse split process. On the one hand, many traders stop buying a stock after the reverse split. A $1 stock might seem to have more upside than a $10 stock; in any case, people are attracted to cheap stocks.
Another issue is that it will trigger more short selling. Many brokers make it difficult or impossible to short sell companies trading below $5 or $2.50 per share. Aurora, back up at $9, will be easy to bet against again.
In addition to that, the company announced that it intends to sell more new shares to the public via a new at-the-market “ATM” offering. This will result in both the company itself and short sellers likely causing downward pressure on the stock price over the next month.
Still A Chance At Recovery
When you look at a 75-cent stock doing a reverse split, you might assume the company is in grave trouble. While Aurora’s short-term prospects are indeed cloudy, the company still has a shot.
ACB still has a market cap approaching $1 billion. Business expanded markedly in recent quarters, and the company confirmed that revenues should continue growing in the back half of 2020 despite the virus.
Going forward, there should be many markets coming online, both as individual U.S. states legalize, and more countries follow suit overseas. While Aurora has had to pare back some of its operations to cut costs, it still has one of the broadest footprints of the marijuana companies, and is set to benefit as the industry gains more adoption around the globe.
And, as of last quarter, the company had substantial cash balances, with nearly 20% of its market capitalization consisting of cash. Throw in proceeds from the ATM sales, and Aurora will be in this for the long haul.
The marijuana market obviously needs to cooperate, but when things turn back up for the industry, Aurora could be a winner.
The Bottom Line on ACB
There’s certainly still an investment case for Aurora Cannabis. The company is down, but it’s not out of the picture. In fact, there are still many positive catalysts that could swing the momentum back in favor of the cannabis companies within the next year.
If you do want to buy the stock, however, there’s no reason to rush. The upcoming reverse split could cause a major decline in Aurora’s stock over the next month. With that set to go into effect on May 11, you should consider waiting until mid-May to make any purchases. For the next few weeks, the trend is likely to continue lower.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.
