The cannabis sector has experienced an extended sell-off over the last 12 months. Most pot stocks were trading close to record highs when Canada legalized the recreational use of marijuana. While valuations were sky-high and warranted a pullback, the expanding addressable cannabis market got investors excited.
Since then, pot companies have been affected by a slew of structural issues including regulatory concerns, the slow rollout of retail stores in Canada's large provinces, and health concerns related to vaping. The ongoing COVID-19 pandemic added fuel to fire and exacerbated this decline.
Shares of cannabis giant Aurora Cannabis (ACB -5.15%) are trading at $0.70 at the time of this writing -- 94% below its record high. Despite this massive decline, Aurora is not quite of the woods. The highly diversified pot producer has a lot going against it. Let's see if the company can make it through without burning investor wealth in the next year.
Cash balance is precarious
One of the major concerns for Aurora Cannabis investors is its low cash balance. In February this year, investment bank Ello Capital claimed that Aurora Cannabis had less than three months of runway left.
According to Aurora's latest filings, it ended 2019 with a cash balance of just above CA$200 million. Comparatively, its current liabilities stood at CA$214 million. Aurora reported an operating loss of CA$119.6 million in the December quarter, which makes short-term liquidity a huge concern.
Last month, Aurora Cannabis announced it might raise $350 million in equity capital in ATM (at-the-market) offerings to shore up its cash balance. Aurora Cannabis increased its share count from 16 million in June 2014 to 1.31 billion in April 2020. In order to continue being listed on the New York Stock Exchange, the company will undergo a reverse split at a ratio of 12 to 1.
This will result in a lower share count and a higher stock price. However, Aurora Cannabis diluted shareholder wealth significantly over the years by raising equity capital in order to stay afloat.
Aurora is paying a massive price for overvalued acquisitions
Aurora Cannabis went on an acquisition spree in the last few years. It acquired companies at high valuations and paid a premium. This premium is also known as goodwill. In short, the difference between the book value of a company and its acquisition price is reported as goodwill on the balance sheet of the acquiring firm.
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In the December quarter, Aurora reported a goodwill impairment writedown of CA$762.2 million. This is an accounting charge, and is recorded if the particular assets no longer generate expected returns. Aurora Cannabis still has CA$2.41 billion as goodwill on its balance sheet. Goodwill accounts for 51.6% of total assets, which means significant writedowns are in the cards.
Aurora Cannabis paid a premium for these acquisitions due to the underlying positive market sentiment prevalent at that time. It burnt considerable cash to acquire these assets. In hindsight, Aurora should have bought similar assets at discounted prices in the current bearish environment. Instead, the company is struggling to maintain operations and has to raise additional capital, and is fighting for survival.
Widening losses and high inventory levels
In the December quarter, Aurora Cannabis reported net revenue of CA$56 million, compared to net revenue of CA$70.8 million in the September quarter, indicating a sequential decline of 26%. However, the company's EBITDA loss also widened to CA$80.2 million from CA$39.7 million in this period.
Aurora's tepid performance in its most recent reported quarter can be attributed to weak wholesale revenue. Its wholesale revenue in the fiscal second quarter was down a whopping 77% sequentially due to uneven demand and a 45% fall in average net selling price.
Consumer cannabis sales were down 24% due to the slow rollout of retail stores in Ontario and other major provinces. Aurora Cannabis' international medical cannabis sales fell 64% due to a temporary sales suspension in Germany.
Aurora decreased its production by 26% to 30,691 kgs in December, which increased its cost to produce per gram by 4% to $0.88. Lower than expected sales also increased the company's inventory to $205.5 million, up from $113.6 million in the first quarter of 2020. This exposes the company to inventory writedowns as well.
What's next for Aurora Cannabis and investors?
We have seen why Aurora Cannabis will be affected in the near-term. While the cannabis market is expanding at a rapid pace, there are far too many players right now. For example, MKM Partners analyst Bill Kirk expects the Canadian cannabis market to consume about 180,000 of pot annually. Aurora Cannabis, on the other hand, has production facilities that can manufacture 150,000 kg per year.
The oversupply issue will continue to affect most Canadian pot producers until retail stores are given licenses to set up shop at a faster pace. Further, in the near-term, no one knows how the COVID-19 situation will pan out and influence cannabis sales.
Aurora Cannabis should consider exiting international operations and reduce costs. In the first six months of 2020, the company generated CA$131.3 million in net sales with 93% or CA$122.4 million in sales coming from Canada.
The international market will be a key long-term growth driver for Aurora Cannabis and marijuana peers. But Aurora needs to ensure it will be able to survive to take advantage of this growth. Right now, Aurora Cannabis will have to take a short-term outlook and focus on operational efficiency instead of growth.
Analysts covering Aurora stock have a 12-month average target price of CA$1.72, according to data from Yahoo! Finance. This indicates the stock is trading at a discount of 73.3% from its target price, which might seem attractive for contrarian investors. However, given the circumstances, Aurora Cannabis stock needs to turn around its business to inspire investor confidence.
