At one time, there wasn't a hotter investment on Wall Street than marijuana stocks. Though there were a number of North American licensed producers that investors fancied, Alberta-based Aurora Cannabis (NYSE:ACB) was often the favorite.
Aurora Cannabis appeared to have a pedigree that would make it a clear winner in the cannabis space. By the midpoint of 2019, it had 15 properties that, if fully operational, could yield in excess of 660,000 kilos of cannabis per year. This would make Aurora the global leader in marijuana production, and presumably allow the company to take advantage of economy-of-scale cost reductions.
Aurora was also the presumed leader in international sales. Taking into account its overseas production, partnerships, research, and export agreements, it had ties in two dozen countries outside of its home market of Canada.
And yet, here we are in June 2020, and Aurora Cannabis has lost almost 89% of its value since legal weed sales began in Canada on Oct. 17, 2018. Within the past nine months, we've seen Aurora Cannabis enact a 1-for-12 reverse split to avoid delisting from the New York Stock Exchange, lay off 500 workers, rework its debt covenant, sell a 1-million-square-foot greenhouse, and halt construction on two of its largest cultivation projects to preserve its capital.
To be frank, investors' faith in Aurora Cannabis has been shaken, if not completely lost. The track record for companies scrambling to reduce costs and enacting reverse splits to avoid delisting isn't good.
However, investor faith can always be restored. In the case of Aurora Cannabis, it's just going to take a lot of work. Here are three things that need to happen for Aurora Cannabis to become an investment-worthy company.
1. Management has to stop diluting its shareholders
Here's an interesting tidbit of information: Over the trailing three-year period, Aurora Cannabis' market cap is up by 175%. However, its share price over that same time frame has declined by 28%. This more than 200-percentage-point performance gap is wholly due to the fact that Aurora's management team is a serial diluter of its shareholders.
Even though Aurora Cannabis was able to access some traditional bank financing, the vast majority of its capital has come from selling its own common stock or using its stock as collateral in the more than one dozen acquisitions it's completed since August 2016. Taking into account the 1-for-12 reverse split that took effect four weeks ago, as well as the recently completed all-share Reliva acquisition for $40 million, Aurora's share count has skyrocketed from 1.3 million in June 2014 to north of 111 million. With the company's board recently approving a $350 million at-the-market share offering, it doesn't look as if this dilution will stop anytime soon.
If Aurora Cannabis wants to get serious about attracting long-term investors, it's going to need to significantly lower its operating costs to stop burning through so much capital, or perhaps strike an equity partnership. The point being that investors are never going to have faith in this company if it their stake is continually diluted by share issuances.
2. Aurora has to figure out how to grow its international business
Secondly, Aurora's management team is going to need to figure out how to ramp up overseas sales.
Even before the coronavirus disease 2019 (COVID-19) pandemic hit, Aurora's overseas sales were anemic -- often coming in around $4.5 million Canadian per quarter. That's simply unacceptable when you consider that Aurora has a presence in 24 countries outside of Canada, and roughly three dozen countries outside of Canada have legalized medical pot, to some degree.
Aurora's acquisition of hemp-derived cannabidiol (CBD) products company Reliva in the U.S. is a start. Aside from being able to lay down infrastructure on U.S. soil (something that could prove lucrative further down the line if the U.S. federal government legalizes cannabis), the Reliva deal adds $14 million in annual sales, nearly doubling what Aurora is generating from outside of Canada on a yearly basis.
But more needs to be done. Aside from Germany, Aurora needs to find other avenues to bolster sales from overseas markets. Perhaps it's able to generate more from other EU countries, or receives a boost from the eventual legalization of adult-use cannabis in Mexico.
The point being that supply vastly outweighs demand in Canada, at the moment, and the only way to mitigate that concern is to have other sales channels at the ready. Until Aurora Cannabis is generating a healthy amount of revenue from overseas markets, I don't see how investors can have faith in the company.
3. The balance sheet absolutely needs to be cleaned up
Third and finally, Aurora Cannabis is going to have to address its ugly balance sheet -- and I mean ugly.
During its fiscal second quarter, Aurora wrote down more than CA$1 billion in net assets, including a CA$762.2 million goodwill writedown. However, even after this writedown, the company still has CA$2.42 billion in goodwill on its balance sheet, which currently accounts for 51% of its total assets.
While it's not uncommon for an acquiring company to pay a premium above and beyond tangible assets (and classify this premium as goodwill), there's pretty much no chance for Aurora to recoup anywhere close to the CA$2.42 billion currently classified as goodwill on its balance sheet. The vast majority of this goodwill comes from the CA$2.64 billion MedReleaf deal. Following the sale of the Exeter greenhouse, it means Aurora paid over CA$2.6 billion to acquire a meager 35,000 kilos in annual output and a handful of unique brands.
If Aurora is going to regain shareholders' trust, it's going to have to come clean about its total assets. In my view, around half of the company's total assets need to be written down. If management were to take their lumps and simply move forward, the company would likely be in much better shape for the long run.