Aurora Cannabis: Lives To Fight Another Day, For Now
Summary
- Aurora is trying to reset its business after failing to reverse its declining revenue and ballooning operating costs.
- We think the company needs to downsize aggressively in order to restore spending balance, including workforce reduction and shrinking footprint.
- The U.S. is the only attractive international market but Aurora's hands are tied with its in-house disarray and leadership void.
- The underperformance at Aurora continues and its viability is further threatened due to the ongoing pandemic.
Aurora Cannabis (NASDAQ:ACB) needs to hit the reset button but it is running into a wall of issues and adverse market conditions. The company recently announced a slew of bad news, ousted its long-time CEO and COO, and is appearing hamstrung by its frail financial position. Going forward, we think there is only one way for Aurora to remain a going-concern and survive in the long term which is to focus on being a profitable Canadian company and scaling back its unprofitable international operations.
(All amounts in C$)
Deteriorating Financials
Aurora is too big to be profitable in its current form. The company has one of the largest international footprints among global cannabis players but it is difficult to see the benefit of its sprawling global footprint. One way of looking at the issue is to benchmark the operating cost structure of the top LPs in Canada. Per the chart below, which includes three buckets of the most common operating expenses, Canopy (CGC) has the highest operating cost in dollar terms with its latest quarterly expenditures reaching a staggering $150 million. Aurora came in second with $107 million of quarterly expenditures which includes $29 million of sales and marketing, $7 million of R&D, and $71 million of general and administrative expenses. There are two observations to be made here: Aurora is overspending relative to its revenue and there is no near-term catalyst for that to change given the lack of top-line growth; most Canadian LPs are spending little to none on R&D, except Canopy, which underscores the consumer nature of their business model.
(Source: Public Filings)
In the last quarter, Aurora announced fiscal Q2 results including net revenue of $56 million. The recent trending of sliding revenue at Aurora reflects a deeper issue at the company that is losing ground in both Canada and abroad. With sales down to $54 million, Aurora couldn't even pay for its operating expenses with revenue, let alone its cost of production or debt interest expenses. There is little prospect of the business rebounding given its management issues, constrained finances, and impact from COVID-19.
(Source: Public Filings)
When Aurora provided a corporate update on February 6, 2020, the company announced intentions of lowering its Sales and G&A to $40-$45 million per quarter by the end of fiscal 2020, which is an aggressive target given its Q2 spendings of ~$100 million. Cutting 25% of the workforce is the first step towards that goal but much more is needed. We think potential actions that Aurora could pursue to lower its costs include shutting down one or more high-cost production facilities, significantly reducing its sales and marketing expenses, and rolling back its global footprint outside Canada.
Writing Off International Assets
We have long held the view that Aurora's international businesses bring very little tangible benefits to the company at enormous costs. The company still generates >90% of its revenue from Canada and its international expansions have all but stalled. In the last quarter, Aurora recorded a $1.4 billion impairment which comprises mostly goodwill write-off. Aurora also wrote down some of its European and South American operations.
Aurora rose to fame with its 2017 acquisition of CanniMed and the $3.2 billion acquisition of MedReleaf in 2018. However, based on recent developments, we think the biggest opportunity lies in the U.S. market. Aurora has already acquired hemp assets around the world but it has not made meaningful deals in the U.S. yet. Aurora owns Hempco in Canada, ICC in Latin America, and Agropro UAB and Borela UAB in the EU. The company has also stated publicly plans to enter the U.S. hemp industry after the 2018 Farm Bill legalized industrial hemp cultivation federally. However, we think the timing has passed and Aurora has essentially been shut out of the fastest-growing U.S. market for the foreseeable future. Based on its financial situation, the company is unlikely to have resources and talent to pull it off.
As a result, Aurora is noticeably missing opportunities to enter the U.S. market like Cronos (CRON) and Canopy did. Canopy and Cronos have both set up a meaningful presence in the U.S. through large acquisitions paid by cash supplied by Constellation (STZ) and Altria (MO), which Aurora doesn't have. Unlike the slow progress in the EU, we continue to see tremendous growth opportunities in the U.S. as more states legalize cannabis. For example, Illinois was the latest market to commence recreational sales on January 1, 2020, and many states are expected to legalize some form of cannabis. Aurora is truly missing a critical part of the global cannabis market that is actually growing.
It is worth mentioning that Aurora previously spun off to its own shareholders a small company called Australis Capital (OTC:AUSAF). Nothing substantial has been accomplished at Australis yet. Due to its lack of track record and limited resources, Australis has limited catalysts.
(Australis Share Price; Source: TMX)
Looking Ahead
Aurora is in a full survivor mode at the moment. We expect the upcoming Q3 release to reflect further deteriorating performance across its operations as remaining management scrambles to save the company. After the CEO and COO are ousted, what's left is a company that is saddled with debt, bloated corporate structure, and excess production capacity. Aurora is only able to survive due to its at-the-market equity issuance program that constantly sells new shares on the open market to raise cash. While it is puzzling that Aurora is the third most bought stock on Robinhood, it is clear that the stock is facing seemingly insurmountable obstacles from here. Cautious investors should avoid this stock as the path forward is highly speculative and risky. Last November, Aurora narrowly avoided an insolvency crisis when one of its convertible debentures matured and it had to essentially "restructure" the debt by lowering conversion price substantially to $3.28 to entice noteholders to convert. Since then, the stock has lost 70% of its value and it is now doing a 1-for-12 reverse stock split to avoid delisting by stock exchanges. We expect Aurora to face severe liquidity shortfall in the coming quarters and its bank lenders likely will not be as lenient as its convertible debt holders.
While we have been following the journey of Aurora as its financial profile becomes stretched over the last 12 months, we also think the biggest potential upside risk to our thesis is a third-party strategic investment. As a standalone company, Aurora was seemingly running out of options to revive its operations after several quarters of declining sales even before COVID-19 hit. However, we view the possibility of a strategic partner or acquirer as extremely low given the chaotic business environment during the current pandemic. Aurora's large cost structure and redundant operating footprint are also less desirable for potential buyers. Many large global alcohol and alcohol firms are fighting to survive themselves and dealmaking is likely at the bottom of their list of priorities at the moment. Therefore, we think Aurora will likely continue relying on its open market equity issuance program to obtain additional liquidity absent a miraculous turnaround in its results.
This article was written by
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.
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Comments (71)
Switzerland's Central Bank Bought Up Apple, GE, and Disney Stock. It Also Loaded Up on a Marijuana Stock. -- Barrons.com
BY Dow Jones & Company, Inc.
— 7:00 AM ET 05/11/2020
To quote: ...The bank also bought 1.8 million additional shares of
Aurora Cannabis to lift its investment to 4.2 million shares at the end of the first quarter.
i should feel grateful for that 34 cent gain.
