I’ll admit: I didn’t predict the post-earnings gain in Aurora Cannabis (NYSE:ACB). Few did. Aurora stock skyrocketed 68% last Friday after delivering fiscal third quarter earnings after the close on Thursday.
I’ll admit this, too: there’s some good news in the report. Sales were not just stronger than expected, but solid. Aurora is cutting costs and mid-term targets appear in sight.
But it’s worth adding a note of caution to the release. Aurora stock still is down almost 85% over the last year. It’s off some 40% from where it traded when I first tried to steer investors away back in February.
Looking forward, the core problems with Aurora stock persist. Margins are a question mark. The balance sheet is a mess. And I’m far from convinced that Aurora’s strategy is the right one.
I believe wholeheartedly in the long-term opportunity in cannabis stocks. I have an entire service, Cannabis Cash Weekly, devoted to the sector. The declines that have faced cannabis stocks since early 2019 have gone too far.
But I argued after the second quarter report that ACB wasn’t the right play even for cannabis bulls. After the Q3 release, even with a 68% gain, I don’t feel much differently.
Good News From Earnings
The headline news from Aurora earnings is that the company got back to growth. Net revenue excluding provisions increased 18% quarter-over-quarter. For cannabis sales, growth was 15% q/q.
And the growth was broad-based. Consumer cannabis net revenue increased 24% from Q2. Management chalked that up to Daily Special, the company’s new value brand. Medical net sales worldwide rose 13.5%, again on a quarter-over-quarter basis.
That type of trajectory was not what analysts or investors were expecting. Net revenue of 75.5 million CAD absolutely crushed consensus projections.
Below the top line, Aurora seems to be delivering on its promises, a notable change from recent performance. For instance, the company aims to keep adjusted gross margins above 50%, and posted a 54% figure in Q3.
But the bigger move is in terms of SG&A (selling, general, and administrative) expenses. The figure was almost 100 million CAD in the second quarter; Aurora is targeting a significant reduction to just 40-45 million CAD.
And Aurora is getting there in a hurry. Q3 SG&A was 75.1 million CAD. On the third quarter conference call, interim chief executive officer Michael Singer said the company exited the quarter at a 60 million CAD run rate. That even includes research and development spending, which is now part of the 40-45 million CAD target.
As a result, Aurora reiterated its guidance for EBITDA profitability in the first quarter of 2021. That, plus strong sales growth, was enough to create Friday’s pop.
Taking a Step Back
Those companies all benefited from growing markets. But those companies took advantage of that growth by aggressively attacking those markets and investing behind their businesses.
Even before the coronavirus hit, Shopify expected to earn less profit in 2020 than it did in 2019. Tesla could have ridden the Models S and X to profitability, but instead made a big bet on the Model 3. Amazon has never prioritized profitability over the customer experience.
Then, consider this statement from Aurora chief financial officer Glen Ibbott on the Q3 call:
We are, however, reaffirming our commitment to manage the business to positive EBITDA in Q1 2020 using whatever additional cost levers we need to…
This is not the time for any company, and particularly a cannabis company, to be focused solely on the near-term. There’s a massive opportunity worldwide. Smaller, weaker competitors are going to fall by the wayside.
But Aurora is focused just two quarters out, and focused solely on cutting costs. Again, SG&A spending is going to drop by more than half. R&D is getting cut as well.
Meanwhile, Canopy Growth (NYSE:CGC) and Cronos (NASDAQ:CRON) have no such problems. Thanks to multi-billion dollar investments from Constellation Brands (NYSE:STZ,NYSE:STZ.B) and Altria (NYSE:MO), those companies can be opportunistic as the industry resets. That’s a key reason why both stocks are part of Cannabis Cash Weekly.
The Balance Sheet Risk to Aurora Stock
To be fair, some of the reduction in SG&A spending is needed. As I’ve written before, Aurora’s past management was careless in terms of both Aurora’s cash and Aurora stock. Shareholders were diluted at an exponential clip as executives made acquisition after acquisition. Aurora overbuilt capacity, and spent far beyond its means.
But current shareholders still are paying for those past mistakes. Aurora isn’t slashing costs because Singer and Ibbott don’t know what they’re doing. It’s slashing costs because its debt is a ticking time bomb.
Aurora finished Q3 with nearly 600 million CAD in debt. It burned over 400 million CAD in cash in just the last two quarters.
Costs have to come down in a hurry — whether management thinks that’s a good idea or not. Meanwhile, Aurora is selling as much as $250 million in stock at the market to raise more capital. Those sales would further dilute shareholders and further depress the Aurora stock price.
That debt is why Aurora is in such a hurry to get to positive EBITDA. It’s running out of time. But positive EBITDA alone doesn’t support a market cap now well over $1 billion. It doesn’t even fix the debt problem.
And the near-term strategy will have a long-term cost. Lower marketing and R&D spending opens the door for rivals to take advantage.
So I’d advise investors to consider the context of the Q3 report. The short-term news is good. The long-term news is not. That suggests that the short-term rally in Aurora stock will end up being precisely that.
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.