It's truly incredible what a difference a year has made in the North American cannabis industry. Throughout most of 2018 and the first quarter of 2019, pot stocks were pretty much unstoppable. Sales growth expectations were through the roof, and Canada had recently become the first industrialized country in the modern era to OK the sale of adult-use weed. It looked as if nothing could go wrong -- and then everything did.
In Canada, regulators struggled to approve cultivation and sales licenses, delayed the launch of high-margin derivatives (e.g., edibles, infused beverages, and vapes), and, at the provincial level, badly botched the retail licensing process in Ontario (the most-populous province). Meanwhile, in the U.S., high tax rates in key states like California made it virtually impossible for licensed producers to compete with the black market on price. And as the cherry on top, North American cannabis stocks have struggled with access to traditional forms of financing.
Aurora Cannabis' painful fall from grace
At this time last year, Aurora Cannabis was forecast to be the leading global cannabis producer, with its 15 properties capable of producing more than 650,000 kilos of marijuana at their peak. It also had a broader international presence than any other pot stock, with production, export, partnership, or research operations in 24 countries outside of Canada. According to Wall Street, Aurora was on track for well over $600 million Canadian in fiscal 2020 sales and would likely be on the cusp of profitability.
But over the past year, we've witnessed Aurora Cannabis halt construction at two of its largest projects to conserve capital (Aurora Sun in Alberta and Aurora Nordic 2 in Denmark), lay off 500 workers, rework its debt covenants, and put its 1 million-square-foot Exeter greenhouse up for sale. Today, Wall Street's fiscal 2020 estimates call for only CA$278 million in revenue and a loss per share of well over CA$1.
It's been my contention recently that Aurora, which boasts CA$4.72 billion in total assets, will have little choice but to take significant writedowns on its goodwill, inventory, and property, plant, and equipment in the quarters that lie ahead. Even after CA$1.02 billion in impairments from the fiscal second quarter, more than half of the company's assets look suspect, in my view.
Aurora's Exeter sale points to the seriousness of capacity struggles in the cannabis space
Quantifying my skepticism for Aurora Cannabis can be difficult at times, especially when figures like goodwill rely on future projections and some finger-crossing. But based on a recent sale by Aurora Cannabis, the evidence is growing that it -- and many of its peers -- will have some big adjustments to make in the not-so-distant future.
As reported by Marijuana Business Daily a little more than a week ago, Aurora Cannabis wound up selling the Exeter greenhouse, which sat on 69 acres, for CA$8.6 million. This was roughly half the CA$17 million asking price for Exeter and 33% of the original purchase price of CA$26 million paid by MedReleaf for the greenhouse and 95-acres of adjacent land. This might not sound like much, at least in nominal dollar terms, but it tells quite the story with regard to capacity demand at the moment.
When Aurora spent a whopping CA$2.64 billion to buy MedReleaf, the expectation was that it would eventually see 140,000 kilos of annual output for its trouble, with 105,000 kilos coming from Exeter. But a plethora of Canadian supply issues, coupled with Aurora's own overzealous spending, never allowed that to happen. Aurora chose not to retrofit Exeter and, this past week, seemingly fire-sold the property.
This essentially means that Aurora paid CA$2.64 billion to acquire 35,000 kilos of annual output and MedReleaf's brands -- and a quick look at Canadian licensed producers shows that 35,000 kilos of annual output can be had today for well under CA$100 million in market cap. This 67% decline from when MedReleaf bought this asset in 2018 to when Aurora sold it last week demonstrates just how overvalued property, plant, and equipment might be on the balance sheets of Canadian licensed producers.
News flash: Aurora's not alone
The scary thing is that Aurora Cannabis isn't alone in its efforts to cut costs and sell off/reduce some of its capacity.
For example, Canopy Growth (NASDAQ:CGC) announced in early March that it would be shutting down its Aldergrove and Delta indoor greenhouses in British Columbia and also wouldn't bring its Niagara on the Lake facility online later in the year. Combined, these three facilities account for at least 3.3 million square feet of licensed cultivation space that Canopy Growth is not going to put to work, an asset that cost the company in excess of CA$400 million to purchase.
Canopy Growth, which is set to report its fiscal fourth-quarter results later this week, has suggested that it will take a charge of between CA$700 million and CA$800 million on a pre-tax basis tied to closing these facilities, as well as other factors, including layoffs and organizational changes.
Likewise, HEXO (NYSE:HEXO) announced that it would close the Niagara facility that was acquired in the Newstrike Brands deal. HEXO has already written down a good chunk of this acquisition and intends to sell the Niagara facility, which is likely capable of more than 40,000 kilos of annual production at peak capacity. The problem is that virtually no licensed producers are looking to boost their capacity at the moment, as evidenced by Exeter's substantial price haircut. This is going to leave HEXO, Canopy Growth, and other Canadian licensed producers with underutilized or unused assets that they simply can't move.
In other words, 2020 might be remembered among pot stock investors as the Year of the Writedown.