Following a precipitous 14-month downtrend that saw Aurora's stock lose as much as 95% of its value and undergo a 1-for-12 reverse stock split in order to avoid being delisted from the New York Stock Exchange, the company's stock has rallied a whopping 158% in a two-day stretch. Both days featured daily volume of close to 100 million, which suggests a lot of short-term trading considering that there are only around 109 million shares of Aurora's stock outstanding (and perhaps less in its float) following its reverse split.
Three reasons Aurora Cannabis has skyrocketed 158% in two days
What has investors so excited that the "FOMO" -- that's fear of missing out -- has returned to Aurora Cannabis' stock? First off, the company delivered sequential quarterly sales growth of 35%, and a net cannabis sales increase of 32% from the sequential second quarter. Aurora didn't sell any low-margin wholesale or bulk cannabis, but saw adult-use weed sales climb 24%, which is likely the result of excitement surrounding the launch of higher-margin derivatives (e.g., edibles, infused beverages, and vapes).
Secondly, management continues to believe that the company's cost-cutting measures have it on track to deliver positive adjusted EBITDA by the fiscal first quarter of 2021 (ended Sept. 30, 2020). As some of you may know, Aurora's new debt covenant requires it to be generating positive adjusted EBITDA by Q1 2021. According to the company's operating results, selling, general and administrative (SG&A) expenses dipped to around $75 million Canadian in Q3 2020 from almost CA$100 million in the sequential quarter. Aurora is targeting between CA$40 million and CA$45 million in quarterly SG&A by Q1 2021.
A third reason Aurora has likely taken off like a rocket is the company's extensive short position. Short-sellers make money when a stock declines in value. Unfortunately for short-sellers, their gains are capped at 100%, while their losses are, theoretically, unlimited. With Aurora's stock moving up so abruptly over the past two days, short-sellers may have been left with little choice but to cover their positions, which only fuels additional upside.
Aurora's total assets may need to be reduced by more than 50%
There's no question that Aurora Cannabis' third-quarter report wasn't a worst-case scenario -- but it wasn't great, either. What worries me is that investors buying into Aurora during its 158% two-day run higher may not understand what they're really getting into. More specifically, what you see on the company's balance sheet isn't necessarily what you're going to get.
In the recently ended third quarter, Aurora's total assets tallied CA$4.72 billion, down from CA$5.5 billion when it ended its fiscal 2019 on June 30, 2019. The reason for the drop over the past nine months ties into a multitude of writedowns and impairments taken by the company in the second quarter. This included writing down CA$762.2 million in goodwill. Based on the U.S. close and market cap of $1.83 billion (CA$2.55 billion) as of Monday, May 18, Aurora probably looks like a book value bargain. But that's not the case.
Currently, 51% of the company's total assets (CA$2.42 billion) are classified as goodwill. This pretty much means Aurora grossly overpaid for the businesses it acquired, and management hopes that it'll be able to utilize the infrastructure, brands, and patents acquired from these companies to recoup the premium it paid. As you can imagine, that's not a guarantee to happen.
The biggest issue with the goodwill writedowns that Aurora took during the fiscal second quarter is that they were tied to its South American and Denmark assets. While these assets were likely overvalued, they're nowhere near as grossly overpriced as the MedReleaf transaction was. Completed in July 2018, the MedReleaf buyout was an all-stock deal valued at CA$2.64 billion, with approximately CA$2 billion classified as goodwill.
The thing is, the 1-million-square-foot Exeter greenhouse, which needed to be retrofit to grow up to 105,000 kilos per year, was the crown jewel of this acquisition. Aurora never wound up moving forward with this retrofit and has put the Exeter greenhouse up for sale. Effectively, Aurora paid CA$2.64 billion for a meager 35,000 kilos in annual output and a handful of unique brands. In my view, nearly all of this CA$2 billion in goodwill may eventually be written off.
This isn't just a goodwill problem...
But that's not all. Inventory levels have been skyrocketing over the past nine months for all licensed Canadian producers. Aurora ended the most recent quarter with CA$251.2 million in inventory, which is more than double the CA$113.6 million it had in inventory on June 30, 2019. Don't get me wrong, having some product in inventory is a good thing. But rapidly growing inventory levels throughout the industry suggest a combination of rampant oversupply and insufficient retail channels to move legal product. There's a growing possibility that some of Aurora's inventory may need to be written down, reduced in price, or even destroyed, if it can't be sold through traditional retail channels.
That leads to the next point: Aurora's CA$1.05 billion in property, plant and equipment. The company already wrote down some of the value of its Aurora Nordic 2 facility in Denmark, but hasn't fully addressed underutilization throughout its portfolio. It's only utilizing 238,000 square feet of cultivation space in the Aurora Sun facility (which currently has construction halted), and has skyrocketing inventory with an annualized run-rate of around 150,000 kilos a year. This was a company gearing up for more than 650,000 kilos of annual output at this time last year.
Lastly, there's Aurora's CA$501 million in intangible assets, which may need to be adjusted based on the retail struggles licensed producers are currently contending with in Canada.
With Aurora's cash balance also likely to decline as the company continues to lose money on an operating basis, I'd contend that Aurora's total assets are more likely valued around CA$2 billion, rather than the CA$4.72 billion investors are seeing today. That makes buying into Aurora because of FOMO a dangerous proposition.