This Latest Correction Does Not Make Aurora Stock Attractive

Stocks to sell

Aurora Cannabis (NYSE:ACB) stock has declined by 79% from 52-week highs. Further, it has declined by 40% in the last two months. Even after the big downside, I remain “neutral” on Aurora Cannabis stock for 2020.

This Latest Correction Does Not Make Aurora Stock Attractive

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I don’t see any positive fundamental triggers that can take the stock higher. Of course, there can be buying opportunities at deeply oversold levels from a trading perspective, but there are lots of factors that make me pessimistic about the business outlook.

Aurora recently announced the early conversion of convertible bonds for $CAD230 million. Equity dilution is one of the reasons for the steep decline in the stock in the recent past. Further, for the first quarter of 2020, Aurora Cannabis reported cash used in operations of $CAD95 million. This implies annual cash used of $CAD380 million.

With meaningful investment required in research & development and marketing, cash burn will result in more dilution. This can keep the stock sideways until there is visibility of positive EBITDA and cash flows.

Regulatory Hurdles Will Continue to Impact Growth

I continue to believe that regulatory hurdle is a major headwind, not just for Aurora, but for the industry.

As an example, it is estimated that Canada needs 1,055 stores to realize the cannabis market’s true potential. Half the number of stores exists currently with 300 stores in Alberta, which has looser regulations. Therefore, even within Canada, the growth of the industry depends on regulations in different provinces.

Another good example of the point I am making is the unavailability of Aurora products in Germany until further notice. German authorities are reviewing the method used by Aurora to increase the shelf life of the flower.

Robert H. Shmerling, Faculty Editor, Harvard Health Publishing, opines that FDA’s regulation of e-cigarettes is still evolving. If there is clear evidence that links e-cigarettes with severe lung disease, the vaping business will be impacted. Aurora is looking at vapes, among other value-added products to enhance EBITDA margin.

In terms of margin and cash flows, higher taxes on the cannabis industry can also have negative implications. As an example, California has a 15% excise tax on retail sale of cannabis, which is in addition to normal state sales tax.

Long-Term Positives

The “legalized” cannabis industry is still at an early stage. This includes medicinal and recreational cannabis. If companies can survive the initial phase of cash burn, there is potential for value creation. According to Aurora Cannabis, the total global cannabis opportunity is $200 billion. This is a big addressable market that can gradually unlock over the next decade.

One of the key positives with Aurora is the fact that the company is focused on clinical research for medicinal cannabis. The company has already initiated clinical studies that are in different phases.

This includes indications like cancer pain management, osteoarthritis, epilepsy, chronic pain, and Tourette’s syndrome, among others. With tighter regulations likely, evidence-based medicine will work in the markets and Aurora is moving in the right direction.

Besides medicinal cannabis, Aurora is also increasing the product portfolio in recreational cannabis. This includes chocolates, mints, cookies, gummies, and vapes, among others. These value-added products can boost EBITDA margin in the long-term.

However, it’s likely only when Aurora can expand in multiple countries with favorable regulations. For 1Q20, Aurora reported international revenues of 5 million CAD with revenue increasing by just 11% on a year-on-year basis. Clearly, there is significant scaling-up that is needed before EBITDA or cash flows turn positive.

 My Final Thoughts on Aurora Cannabis

Aurora has slumped since April 2019 and there seems to be no end to the correction. Regulatory challenges, equity dilution and slower than expected industry growth are factors that have impacted the stock.

These factors, along with cash burn, will continue to dominate the stock trend in 2020. I don’t expect Aurora Cannabis or any other player in the industry to be cash flow positive even in 2021. Therefore, it makes sense to remain in the sidelines and capitalize on short-term trading opportunities. I still don’t see it as a good long-term investment.

As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.

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