The long-term outlook for the cannabis industry remains bright. After worldwide sales totaled $10.9 billion in 2018, a more than tripling from the $3.4 billion in legal revenue recorded in 2014, various Wall Street estimates have forecast $50 billion to $200 billion in global sales by the end of the next decade. Such growth would allow a variety of marijuana stocks to succeed and, presumably, make their shareholders a handsome profit.
But as we've learned from all next-big-thing investments, no industry ever launches without growing pains. The past six-plus months have been filled with growing pains for the marijuana industry, which is contending with supply concerns in Canada, tax issues and oversupply worries in select recreationally legal U.S. states, and a host of other issues.
Near-term concerns haven't kept investors away from Aurora Cannabis
Of course, this hasn't stopped investors from making Aurora Cannabis (NYSE:ACB) their favorite pot stock. In fact, based on data from online investing app Robinhood, no stock on the Nasdaq or New York Stock Exchange was more widely held earlier this year than Aurora Cannabis.
Why Aurora? The simple answer is that investors really like big numbers. No marijuana grower is expected to produce more on an annual basis, when operating at full capacity, than Aurora Cannabis. The company's 15 cultivation facilities should be producing at an annual run-rate of at least 625,000 kilos by the end of its fiscal 2020 (June 30, 2020), and it has the potential to reach 700,000 kilos of annual output by simply maximizing efficiency at its existing farms.
Investors likely also appreciate Aurora's international reach, as measured by grow farms, partnerships, research projects, and/or export agreements in place outside of Canada. Just three pot stocks have a presence in at least a dozen foreign markets, with Aurora leading the pack. Including Canada, the company has access to 25 markets.
There's also the growing likelihood that Aurora will announce a brand-name partnership in the not-so-distant future. This is a company that, earlier this year, hired billionaire activist investor Nelson Peltz as a strategic advisor. Peltz has a long history of working with food and beverage companies, which is perfect for Aurora given its desire to launch an assortment of food- and beverage-based marijuana derivatives.
Wall Street cuts the most popular marijuana stock down to size
But it's important to remember that Wall Street isn't a popularity contest, and even popular stocks can sometimes get put through the ringer. Over the past month, Aurora Cannabis has been hit with not one, but two separate sell ratings from Wall Street following the release of its fourth-quarter operating results.
The first came from covering analyst Andrew Carter at Stifel. And yes, this is the same investment firm that made the aggressive call for $200 billion in worldwide weed sales annually in a decade. Carter wound up reducing his firms' rating on Aurora to sell from hold, and slashed the company's price target from $7 Canadian (US$5.27) to CA$5 ($3.76). Coincidentally, Carter's lowered price target is almost precisely where Aurora closed this past Thursday, Oct. 10.
In reducing Stifel's rating and price target on the company, Carter noted domestic weakness and "difficulty to continue positioning for the larger global opportunity." Carter also cites potential financing concerns, which is the "ticking time bomb" my colleague Keith Speights recently referenced (i.e., Aurora's CA$230 million convertible note due in March 2020).
Not long thereafter, MKM Partners initiated coverage on Aurora Cannabis, anointing it with a sell rating and a CA$5 price target. In a research note to clients, MKM covering analyst Bill Kirk remains concerned that growing supply and already declining per-gram pricing for dried flower is going to make profitability challenging for cultivators.
Furthermore, Kirk believes that Aurora will need to raise capital before generating positive EBITDA (earnings before interest, taxes, depreciation, and amortization), and that the company's focus on medical marijuana limits its overall opportunity.
Aurora Cannabis may fall below $3
Though Wall Street ratings can often be taken with a grain of salt, these sell ratings on Aurora look to have hit the nail right on the head. With growers facing a bounty of issues, including falling per-gram dried flower pricing, ongoing supply issues, slow dispensary store rollouts, and delays to the original derivative launch timeline, Aurora and its peers have virtually no chance of meeting investors' pie-in-the-sky growth projections.
Additionally, as Carter alluded to, Aurora is counting on its two dozen foreign markets to drive medical marijuana sales growth. Unfortunately, these markets aren't going to come into play until domestic demand is satisfied, which could take years at this rate.
But if there's one thing that I believe Carter and Kirk both overlooked in their analysis of Aurora Cannabis, it's the bigger time bomb known as goodwill -- i.e., the premium paid for acquired companies, above and beyond tangible assets.
I've previously opined that goodwill could be an up to $10 billion powder keg for the cannabis industry, with Aurora Cannabis effectively holding the match. As of the fiscal fourth quarter, Aurora had CA$3.17 billion in goodwill on its balance sheet, which represents 58% of its total assets. In an ideal world, Aurora is going to recoup the premium it paid for its more than one dozen acquisitions since August 2016, thereby removing this goodwill from its balance sheet. Unfortunately, the marijuana industry is far from ideal, and the likelihood of a writedown grows by the day.
Aurora Cannabis will likely entice investors based on its low share price, but with more than 1 billion shares outstanding, its $3.7 billion market cap remains bloated given the headwinds it's facing. Smart investors would be wise to distance themselves from Aurora, which may very well dip below $3.