It might not quite be summer officially yet, but several pot stocks are already hot. And only one of them with a market cap of greater than $500 million skyrocketed nearly 70% in May -- Aurora Cannabis (ACB -2.40%).
Aurora ranks as arguably the hottest big marijuana stock on the market right now. But could its sizzle soon fizzle? There are three reasons why the answer could be "yes."
1. Squeeze freeze
Aurora surprised investors with its better-than-expected Q3 results a couple of weeks ago. Its revenue soared 18% quarter over quarter. Its cash burn was lower than in the past. Put simply, there was a lot to like for most investors. But not for everyone.
At the time of its Q3 update, over 19% of Aurora's outstanding shares were sold short. When Aurora beat expectations, it's a near-certainty that some of the short-sellers quickly moved to cover their losses by buying Aurora stock. This created greater upward pressure on the cannabis producer's share price, which increased short-sellers' anxiety even more. The huge jump for Aurora's shares over the past two weeks looks like a classic short squeeze.
However, short squeezes don't last forever. It's only a matter of time before all of the short-sellers who are going to cover their positions have done so. The end of the short squeeze will also likely mean the end of Aurora's impressive run.
2. Dilution solution
It's no secret that Aurora has been notorious about issuing new stock to raise cash over the last few years. The company's market cap has risen over 16 times more than its share price as a result of the massive stock dilution. But Aurora needed the cash, so taking this route was a necessary evil. Unfortunately, the necessary evil could linger around for a while.
Aurora maintains that it should generate positive adjusted EBITDA in the quarter ending Sept. 30, 2020. However, interim CEO Michael Singer said in the company's Q3 call that there's still considerable uncertainty related to the impact of the COVID-19 pandemic. He acknowledged that Aurora might have to access its at-the-money (ATM) facility to issue more shares. If that happens, more dilution will be on the way -- and so will falling share prices.
Keep in mind, also, that positive adjusted EBITDA isn't true profitability. The "I" in EBITDA stands for interest. Aurora has a huge debt load and will have to pay a lot of interest. The "T" in EBITDA (taxes) will also rear its ugly ahead if and when the company begins to make a profit.
3. The curse of rising expectations
I couldn't think of a rhyme for the third reason why Aurora's sizzle could fizzle. But this final factor could be just as problematic for the company as the potential end of the short squeeze and the prospects for more dilution.
After a long period where no one expected much from Aurora, expectations are now rising for the cannabis producer. Analysts are looking for better numbers in Aurora's future quarterly updates. The company is now at long last jumping in the U.S. cannabis market with its acquisition of Reliva.
However, there can be a curse associated with rising expectations. Aurora now has a higher bar to jump. And there are a lot of things that can go wrong. Retail cannabis stores in Canada might take longer to open than anticipated. Consumers could tighten their belts and spend less on recreational cannabis products. Any failure by Aurora will translate to a harder fall for its stock.
There's one final observation (and rhyme) that I'd like to make about Aurora Cannabis. I think that it's quite possible that the company will be a big winner over the long run despite its current challenges. Yes, Aurora could be greater later.
I still think that the global cannabis market will grow much larger than it is now. I expect that the U.S. will change its federal laws to allow cannabis sooner or later. My take is that Aurora could make it past the difficulties of the present and profit in such an environment.
That's not a resounding endorsement of the stock, mind you. I suspect that Aurora could be successful, but there's no guarantee. Also, while Aurora could be greater later, there are other stocks to buy that are great now.