The past 12-plus months have not been kind to marijuana stock investors. Following many years of outperformance and a first quarter (of 2019) that saw more than a dozen popular pot stocks gain at least 70%, cannabis stocks have been stuck in a perpetual downtrend ever since. In fact, most pot stocks have lost anywhere from 50% to 95% of their value since the beginning of April 2019.
This weakness can be blamed on exorbitant tax rates in the U.S. that have made it difficult for licensed producers to compete with illicit growers, and regulatory issues in Canada that have challenged the rollout of dried cannabis and derivative products.
Aurora Cannabis is the marijuana industry's biggest disappointment
But there's not a marijuana stock that's been more disappointing than Aurora Cannabis (NYSE:ACB). At one time, Aurora was projected to produce more cannabis per year (at its peak) than any other grower, and it had access to more overseas markets than any other licensed producer. And to this day, it still remains the most-held stock on millennial-focused online investing app Robinhood.
Unfortunately, Aurora Cannabis has been a veritable dumpster fire. The company continues to lose money at an extraordinary pace, and it appears to lack the cash needed to meet its expected liabilities over the coming 12-month period. For Aurora Cannabis, issuing its stock as if it were Monopoly money has been its primary means of raising capital and paying for acquisitions. Since the end of June 2014, the company's outstanding share count has grown from just 16 million shares to more than 1.31 billion shares, and the initiation of a $350 million at-the-market share offering last week may pave the way for another 500 million shares to be sold.
The culmination of Aurora's struggles was the announcement last week that it'll be enacting a 1-for-12 reverse stock split on or about May 11, 2020 in order to regain compliance with the New York Stock Exchange to avoid delisting.
Yet, getting its share price back above $1 doesn't make Aurora's many problems disappear. On the contrary, with delisting now out of the way it may shine light on the growing likelihood that a trio of writedowns awaits this highly dysfunctional licensed producer.
A goodwill writedown looks all but certain
First of all, I see an all-but-certain additional writedown in the company's future concerning the $2.41 billion Canadian in goodwill it ended with in the fiscal second quarter.
Aurora Cannabis hasn't been shy about making acquisitions, with the most popular pot stock gobbling up more than a dozen companies since August 2016. However, hindsight being what it is, these deals wound up being grossly overpriced and the premium paid looks highly unlikely to be recouped by Aurora. Even after writing down CA$762 million in goodwill during Q2 2020, Aurora's remaining goodwill accounts for 52% of its total assets, and perhaps an even higher percentage in future quarters if operating losses continue to eat away at its cash on hand.
What makes a writedown exceptionally likely, in my view, is that the CA$762 million impairment in Q2 2020 was mostly tied to its assets in South America and Denmark. However, the CA$2.64 billion MedReleaf acquisition is, hands down, the worst deal of all time. There's absolutely no way for Aurora to justify a CA$2.64 billion price tag for 35,000 kilos of annual output and a couple of proprietary brands. Remember, the 1-million-square-foot Exeter greenhouse, which was a highlight of this deal and touted as being capable of 105,000 kilos of cannabis output per year, once retrofit, is now up for sale for a mere CA$17 million.
A writedown on idled or underutilized assets may be necessary
A second impairment that may await Aurora Cannabis concerns the value of its property and equipment.
Along with the massive CA$762 million goodwill writedown, Aurora also wrote down nearly CA$52 million in the value of its property, plant & equipment during Q2 2020. This bulk of this writedown was tied to the construction halt at the 1-million-square-foot Aurora Nordic 2 facility in Denmark, with the value of the real estate, production equipment, and land also adjusted lower.
The problem is that the Aurora Nordic 2 facility isn't the only asset that could sit idle or underutilized while Canada works its way through regulatory issues. Aurora Cannabis has also halted construction on the 1.62-million-square-foot Aurora Sun facility in Alberta and plans to only utilize 238,000 square feet (six grow rooms) for the current fiscal year. Without an improved retail presence in Ontario, which is unlikely to happen with the proliferation of the coronavirus disease 2019 (COVID-19), Canadian markets simply can't absorb any additional production from Aurora Cannabis.
Facing the realization of extended production downtime or underutilization, coupled with the fact that it would be virtually impossible to sell these assets at anywhere near fair value right now, I'm expecting the CA$1 billion value of property, plant & equipment recognized on the balance sheet to decline in the coming quarters.
A writedown on excess inventory could be in the offing
In addition to the above two writedowns, I also view it increasingly likely that Aurora Cannabis may need to take an impairment on the value of its inventory,
According to MKM Partners' covering analyst Bill Kirk in February, Canada's entire legal market has been consuming about 180,000 kilos of pot on an annual run-rate basis. Aurora Cannabis by itself is on track to produce approximately 150,000 kilos in fiscal 2020. Even though we're going to see Canada's legal run-rate demand improve as more retail stores open for business in key provinces like Ontario, existing output is already flooding the market -- and these licensed producers aren't anywhere near their peak potential.
As of the end of December 2019, Aurora Cannabis had CA$205.5 million in built up inventory, which trails only the CA$622.6 million in inventory that Canopy Growth is sitting on. At the current annual run-rate, and taking into account smaller licensed producers that aren't public, there might be enough cannabis in inventory to satiate Canadian demand for the next two years without growing an additional plant.
Aurora's marijuana can't sit on the sideline forever, which makes ongoing supply bottlenecks a likely reason to write down some of the value of its inventory.