Aurora Cannabis Should Fight For Survival, Not Push For Growth

Summary

• Medicinal Cannabis growth to remain sluggish with lack of research impacting product credibility.
• Cash burn to sustain in the coming years and it implies further equity dilution.
• Recreational cannabis will face regulatory headwinds in efforts for global expansion.

Initiating Coverage

I am initiating coverage on Aurora Cannabis (NASDAQ:ACB) with a "Neutral" outlook.

At the onset, I want to pretend as an investor who has never tracked the stock of Aurora Cannabis. The investor opens the February 2020 presentation of the company and notes the following points:

• Aurora Cannabis is earning its leadership position in a $200 billion industry
• The company currently has a production capacity of 150,000 kilograms per year of dry cannabis
• The company has sales and operations in more than 20 countries with a leadership position in Canada
• The company has robust investments in R&D with 108 patents filed-to-date

This certainly makes me excited. The company has a total addressable market of $200 billion and seems to be pursuing rapid global expansion.

When I look at the stock price of this potentially high growth company, it touched a high of $10.32 in March 2019. Since those highs, the stock has plunged by 89% to $1.17.

I am initially perplexed. But a deeper investigation leads to the conclusion that Aurora Cannabis should be avoided even after the big plunge. Sure, there can be trading bounce back from oversold levels, but Aurora Cannabis is still not a long-term investment stock.

This initiating coverage will discuss the factors that will translate into relatively sluggish growth for the company and hence makes the stock unattractive.

Medicinal Cannabis Growth Will Remain Sluggish

For Aurora Cannabis, there are two broad business segments - Medicinal and Recreational cannabis.

In the medicinal cannabis segment, I believe that top-line growth will remain muted for the coming years. Growth in the medicinal cannabis segment has already been disappointing.

For the quarter ended September 2019, the company reported medicinal cannabis revenue of $30.4 million. For the quarter ended December 2019 (Q2 2020), medicinal cannabis revenue declined to $27.4 million.

For an industry at an early growth stage, quarter-on-quarter decline in revenue is disappointing. Even on a year-on-year basis, there is nothing exciting to talk about in terms of growth.

However, a more important discussion is the reason why medicinal cannabis revenue will remain weak in the coming years.

I want to start with what the U.S. Food & Drug Administration has to say on medicinal cannabis. According to the FDA:

To date, the FDA has not approved a marketing application for cannabis for the treatment of any disease or condition. The agency has, however, approved one cannabis-derived drug product: Epidiolex (cannabidiol), and three synthetic cannabis-related drug products: Marinol (dronabinol), Syndros (dronabinol), and Cesamet (nabilone). These approved drug products are only available with a prescription from a licensed healthcare provider. Importantly, the FDA has not approved any other cannabis, cannabis-derived, or cannabidiol (CBD) products currently available on the market.

The FDA further states the following:

FDA is aware that unapproved cannabis and/or unapproved cannabis-derived products are being used to treat a number of medical conditions including, AIDS wasting, epilepsy, neuropathic pain, spasticity associated with multiple sclerosis, and cancer and chemotherapy-induced nausea. However, the use of unapproved cannabis and cannabis-derived products can have unpredictable and unintended consequences, including serious safety risks. Also, there has been no FDA review of data from rigorous clinical trials to support that these unapproved products are safe and efficacious for the various therapeutic uses for which they are being used.

These statements from the FDA are enough to elaborate on the reason for medicinal cannabis growth remaining sluggish.

For now, the medicinal products by Aurora Cannabis or any other cannabis company are largely based on claims. This is unlikely to boost consumer confidence or the confidence of doctors to recommend these products.

I can say that Aurora Cannabis is moving in the right direction. The company has 40 clinical studies underway, 7 pre-clinical studies, and 27 clinical studies under discussion. However, even if these studies are successful, it will be a few years before further FDA approval is received.

During this period, Aurora Cannabis will continue to face cash burn and additional funding for R&D. Therefore, I don't see the cash burn ending anytime soon. This implies equity dilution, which is negative for the stock. It is for this reason that I believe that Aurora Cannabis should focus on survival than push for growth in multiple countries.

Coming back to the medicinal cannabis outlook, the U.S. has granted $3 million to "fill gaps in medical marijuana research." According to Dr. David Shurtleff, deputy director of the National Center for Complementary and Integrative Health - "The science is lagging behind the public use and interest. We're doing our best to catch up here."

These observations clearly point to the fact that the medicinal cannabis segment needs more funding and research before its adoption accelerates. This also explains the reason for the stock sliding by 89%. Initially, the stock surged due to irrational exuberance considering the total addressable market. However, the reality is being discounted in the valuations. Big growth is years away and subject to research approvals.

Headwinds Exist Even For Recreational Cannabis

I am focusing on the research aspect of cannabis in this initiating as consumers are more informed and purchase decisions will be impacted by observations by FDA, among others.

I believe that top-line growth will disappoint even in the recreational cannabis segment. Even if growth is healthier as compared to medicinal cannabis, it's unlikely to be enough to trigger the stock upside.

The recreational cannabis is important to discuss since the company has launched Cannabis 2.0 products in December 2019. These products include vapes, concentrates, gummies, chocolates, baked goods, and mints.

If we look at what the FDA has to say, the authority warned 15 companies in November 2019 for illegally selling various products containing cannabidiol. Further, according to the FDA:

Based on the lack of scientific information supporting the safety of CBD in food, the FDA is also indicating today that it cannot conclude that CBD is generally recognized as safe among qualified experts for its use in human or animal food.

While Aurora Cannabis is launching products like gummies, chocolates, baked goods and mints, the FDA is uncertain on the safety of these products. I am not suggesting that people will not consume these products. Even tobacco is harmful and consumed widely. All I am suggesting is that growth is likely to be hindered.

According to the National Institute of Drug Abuse:

THC is able to alter the functioning of the hippocampus and orbitofrontal cortex, brain areas that enable a person to form new memories and shift his or her attentional focus. As a result, using marijuana causes impaired thinking and interferes with a person's ability to learn and perform complicated tasks.

The reason for highlighting these factors is also to underscore the point that recreational cannabis expansion in multiple countries is likely to face regulatory headwinds.

Overall, recreational cannabis growth can be faster than medicinal cannabis, but it might not be enough to attract renewed investor attention.

Some Thoughts on Cash Burn

In my view, the next few years will determine the players who survive the current phase of cash burn. The coming years will not determine the market leader, but the market survivors.

For Aurora Cannabis, the company reported EBITDA loss of $119.9 million for the six months ended December 2019 as compared to EBITDA loss of $112.3 million for the comparable December 2018 period. Therefore, EBITDA losses have widened and annualized EBITDA loss is at nearly $250 million.

Further, the company's cash used in operations for the six months ended December 2019 was $230 million. This implies an annualized cash used in operations of $460 million.

As of December 2019, Aurora Cannabis reported cash & equivalents of $156 million. Considering the rate of cash burn, Aurora Cannabis would need funding to continue the business. The cash burn concern is another key reason for the stock declining sharply.

Since profitability is still years away, Aurora Cannabis needs to focus on limited geographic regions and preserve cash than ramp-up selling & marketing efforts. The focus should be on investing in clinical trials and research. This will add credibility to the company's products and trigger sales growth.

Concluding Thoughts

Aurora Cannabis faces multiple headwinds that include sustained cash burn, dilution concerns, slow top-line growth, and regulatory headwind. These factors are likely to keep the stock depressed.

There can be trading opportunities, but Aurora Cannabis is far from being a portfolio stock.

I, therefore, remain "Neutral" on Aurora Cannabis even after an 89% downside in the last one year.

It remains to be seen if Aurora Cannabis can survive an extended period of cash burn. I see significant cost cutting in the coming quarters in this fight for survival.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[lovineveryminutofit]

When is ACB going to realize that recreational users want low priced ditch weed that is legal, easy to buy, and well packaged. Very few smokers are willing to pay $1000 an oz, or more for exotic skunk. Get with it or go broke. $1000 per lb can make us all rich!

[Bay Area Kid]

Recreational users don't want ditch weed and nobody is spending $1000 per oz...

[Jan Schutte]

ACB has realized, you just haven't done your due dilligence. Look at the online ontario store (OCS.CA) and click on the dry flower. You'll see Daily Special with the lowest price per % THC.

[User 45520296]

@Jan Schutte shame that they can't pay dividends with their surplus crops. such a waste.

[PenelopeVitale]

$ACB is remaining quiet in this time of turmoil. Is it because they have matured and are silently trying to survive or are they working on something huge?

[Street Smart Investor]

They have already launched 2.0 Cannabis. They might be thinking of cannabis beverages. But the key game changer can be medicinal cannabis. They are focusing on that.

[User 45520296]

@Street Smart Investor I understand that Terry Booth sold 12 million shares. Still holding, see no point in selling now as the company could right the ship.

[ClLockwood]

Today there will be more blood. $ACB looking like it may be south of a dollar soon. ACB team needs an update this week, or things will likely get ugly with ATM financing and dilution. I am confident we hear something soon. If no positives this month, do we plan the funeral?

[Jan Schutte]

ACB did sell stock under their ATM program of approx. $7,5 million dollar last quarter. If you would do some due dilligence you could see that they only sell shares in favorable times. Pre market is up 13,8% now.
(EDITED)

[Street Smart Investor]

Yes, considering the rate of cash burn, they need financing soon. Within the next month or two.

[Jan Schutte]

No they don't. Capex will be 50 million this quarter.

[MaryLeach78]

$ACB has already gotten rid of SInger and Battley, the two that ran this company into the ground. Nelson Peltz is still on board and they brought in two other folks that are suppose to be very good at repairing broken companies. ACB needs a partner with deep pockets and Nelson Peltz and the helm.

[User 45520296]

@MaryLeach78 certainly is encouraging. good CEOs are expensive for a reason!

[Donnascott]

There are a number of factors that have "amplified" ACB's problems of late...the general health of the stock market in face of a global pandemic not the least of them! Then plug in the abysmal state of marijuana sales in Canada due to delays in licensing issues and you have a second "amplifier"? Then we have to consider the price ACB has paid to remain "in control"...unlike firms like Canopy and others who sold out control for big money, but even Canopy just announced cost cutting efforts that nearly paralleled ACB's own recent actions including closure of two facilities and layoffs of about 500? But lastly and most concerning are ACB's balance sheet challenges. We do expect to see improvements in both top and bottom lines, as a result, next quarter with recent losses, hopefully, offset, at least in part by derivative sales? Long term prognosis for ACB still looks promising as long as they can maximize "cash burn" efforts and focus on "non-dilutive methods" for raising capitol in the near to short term.

[fidel george]

I invested quite a bit early last year after reading all the articles about how ACB was expanding and how the profits were skyrocketing. Turned out to be all lies and a total rip off money marketing scam with really no ties to the sale of marijuana which is on the rise.

[User 45520296]

@fidel george so sorry happens to the best of us. caveat emptor!

[rebelsyntax]

Loving the opportunity to get on this at a dollar. Ive been slowly adding 100 shares here 100 there. Now i can ramp up to 200 here 200 there. Lets keep the price down here for a while so i can continue to accumulate. I like the sector. If the company has to dilute me to weather the storm amd work out the supply chain and wait for government to catch up to the market, so be it. I'm buying on the way down and waiting patiently for the rewards. This company won't go bk so at the worst, I'll be setting up a long term portfolio at the max possible gains. I'll take 50 shares a week please, thanks! Just one less sushi dinner a week, no biggie.

[Mebarrett3]

But there are so many better values in mj that don’t have so many problems.

[Steeley]

Everybody has problems Mark (except the black market folks..). It's only the ones on the main US boards that are compelled to talk about 'em in detail.

[Becerra Design Studio]

Finally fell below $1, now I'm considering investing in this stock.

[HardytheTrader]

No need to be neutral on ACB. Its very likely headed to zero. Who would be stupid enough to lend them money now that we are amidst of economical chaos? Sell it while you can! You might be able to get one quality stock on discount with your proceeds, no matter how small

[Steeley]

Well, since Aurora Cannabis isn't licensed to do business in the US, all the references to the US regulators (FDA, et al.) is pretty much irrelevant.

Forget about the US market when it comes to the Canadian cannabis companies, at least for the next few years (if not decades).

As for the decline in medicinal, this is normal when the adjacent recreational market opens.. some part of the former medicinal consumer is going to forego the additional cost of medicinal authorization (medical cards, doctor prescriptions, etc.) and just "self-medicate" using the recreational supply. Here in Washington state medicinal went in the tank when recreational sales were legalized. The medicinal sales are still there, they've just shifted to the "recreational column" on the revenue ledger.

Anyway, since the article is pretending to be "an investor who has never tracked the stock of Aurora Cannabis", that pretend naivete' I presume was carried into the body of the analysis intentionally.

"It remains to be seen if Aurora Cannabis can survive an extended period of cash burn. I see significant cost cutting in the coming quarters in this fight for survival."

That is true (for all Canadian legal suppliers) but not for the US-based reasons stated. (The U.S. has no legal pathway for non-US cannabis).

For Canadian Companies, the headwinds are provincial (and to an extent, EU and SA export, NOT U.S.) regulators that are being gatekeepers between the cannabis suppliers and the legal market. You'd almost think the regulators are getting significant bribes from the black market suppliers (or legal local producers in foreign markets) to avoid doing anything to allow the legal Canadian suppliers to make inroads into the local market (black or foreign).
THAT is the major reason the legal Canadian suppliers are having to cut back their operations - they have an over abundance of product and capacity they can't leverage through legal channels - they're not being permitted to compete for the complete market.

[User 45520296]

@Steeley such a shame, it could have been part of the USMCA trade agreement. Even Mexico has legalized recreational use. Still too much opposition in the USA; however, it would seem reasonable to include marijuana under the "Right to Try" law signed by President Trump to allow terminally ill patients to take experimental drugs that have not been approved by the FDA.

[User 45520296]

@Steeley yes except a medical card is helpful if you have a job where you are drug tested for example, or a veteran. The VA does not approve of using cannabis for pain or ptsd. But yes, if you live in a recreational state you have access to all the high quality marijuana your little heart desires.

[Steeley]

All I've found the medical card good for (I have one) here in Washington state is the ability to grow up to 15 plants, and out of state travel - most of the cannabis-legal/tolerant states who do not permit non-residents to purchase, do typically allow out of state card holders to possess personal amounts, and even in those that aren't so "open minded", showing the potentially-arresting officer my VA ID and state medical card is likely going to turn into a "get out of jail free" pass (as long as I'm not in possession of copious quantities packaged in such a way that could be construed as intent to distribute, anyway).

If you don't grow and don't travel much there's no reason to spend the money for the annual doctor visits to get, or renew the card - same or similar product in both the recreational and dispensary outlets (and the recreational outlets are often cheaper, even with the medical tax break).

Now, that's my state, your mileage may vary a bit elsewhere.

[db1977]

Put it all on Aphria, Canopy or Cronos.

[drbob512]

agree with your headline. think acb is trying what you say

[Steeley]

There is only one FDA approved CBD consumable product so far, and that is because one (domestic) company spent a whole bunch of money to prove that the product was medically valid for a particular type of seizure. If any company expects "the government to pay for it" and do the research they're going to wait for a long long time. ACB recognizes (I think validly) that their only way into the US (and additional countries not already accepting imports) market is through the pharma path with a clinically proven, and proprietary, product.
I think it's a long shot, to be honest, but whether that research expense is the best use of resources given the domestic legal market access issues the Canadian companies are facing is a good question. Still, I believe the ones in the best position to know the answer is ACB's management itself - they know what their financing options are, their survival prospects, and the maturity status of their research. Everyone else is on the outside looking in and guessing.

[trustfun]

anyone here wanna loan me a $1?

[Jan Schutte]

This is a short article. Management has made significant efforts in to reducing capex. Including: halting production of some of their facilities saving $190 million, cut 20% of the staff, bringing capex to 100 million over the next to quarters starting this quarter. Sales in Germany will be resumed after halting in the last quarter (that's why the medicinal sales declined), Cannabis 2.0 be included in this report and they launched daily special to combat the lower margin product types.

Could you do more research next time?

[Jethro Powers]

Another thing not mentioned is Aurora's faulty packaging resulting in detrriorated product causing inferior end user experience. If they don't fix that soon then nothing else will matter.

[Jan Schutte]

Faulty packaging? what do you mean, I've only seen people getting to much packaging but that's all.

[Jethro Powers]

There's a youtube video where a guy talks about doing his due diligence on Aurora stock, where he calls a bunch of dispensaries asking about various brands product quality, and gets a lot of negative feedback from the managers of the dispensaries about Aurora. So then he pays a visit to a dispensary near him, again asking about the qualities of the various manufacturers products, and gets more negative feedback about Aurora from the manager, who then proceeds to open an Aurora product and a comprable competitors products, and the difference in freshness was obvious.

This would serve to explain their weak sales and high return rste.

[Anshuman_S]

i would say all that big 'talk' of growth ended when cam battley left, which i recall was a big down day for this stock. I left with whatever i could salvage after suffering through a 60% decline in my holdings

[seanmccluskey]

another space filler article. absolutely nothing new here. maybe you haven't been watching the news lately. move on little man. there's a lot more pressing issues.

[Jethro Powers]

Of course there's nothing new here since this isn't a news article. Most of us were able to figure that much out.

[TrumptyDumpty]

Yeah they stopped pushing for growth weeks ago...its pretty well documented.

[Street Smart Investor]

They should not have launched Cannabis 2.0. It's a mistake, in my opinion. It will not boost sales and the company loses the opportunity for a bigger and better launch in the future.

[TrumptyDumpty]

no doubt about it. if theres a bad decision to be made....you can count on ACB to make it

[Bay Area Kid]

"They should not have launched Cannabis 2.0. It's a mistake, in my opinion."

Don't launch the only products that have the margin to make a profitable business? What an awful idea...

[chucklab]

The End is getting Closer for ACB.

[Street Smart Investor]

It all depends on the ability to get some financing relatively soon. And to scale back operations in multiple countries. Focus on clinical trials.

[Anshuman_S]

capex is way too high, imo the true separation of aurora vs canopy happened in q4... aurora had returned product, and a dismal 56 mil revenue, whereas canopy had more than double that, and posted a small loss. I'm invested in neither... i go with stocks that have a p/e

[Street Smart Investor]

Yes, the entire cannabis pack should be avoided in my opinion. There can be a promising future, but not so soon. I think the focus should be on consolidation in Canada, gradual inroads in Europe (Germany) and U.S. Besides clinical trials for evidence based medicinal cannabis.