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3 Red Flags for Aurora Cannabis' Future

By Sushree Mohanty - Dec 2, 2020 at 6:40AM

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Investors should keep a close eye on derivatives and two other factors before investing in this Canadian pot stock.

Canada-based Aurora Cannabis ( ACB 2.58% ) had a disastrous 2019. Its stock price slid so far that the company risked being delisted from the New York Stock Exchange (which will boot a company if its price stays below $1 for long enough). Only a 1-for-12 reverse stock split in May saved it from that fate.

Of course, that financial sleight of hand did nothing to address its core issues. And despite some intense efforts in 2020, the company has failed to bounce back. Aurora's consistent inability to achieve positive earnings before income, tax, depreciation, and amortization (EBITDA) has left investors skeptical. Management did announce a new series of business transformation efforts in June to cut costs and conserve cash, but while those changes have helped bring costs down, they haven't been sufficient to make the company profitable yet.

A man holding an umbrella over a dollar bag and a risk sign

Image source: Getty Images.

On Nov. 10, Aurora Cannabis delivered its first-quarter fiscal 2021 results, and the report only served to highlight its distressed condition. Although management has consistently assured investors that Aurora will achieve positive EBITDA in its fiscal second quarter (the end of which is just a month away), I still see a lot of red flags.

1. It isn't making progress with cannabis derivative products

Canada legalized "Cannabis 2.0" products in October 2019, allowing the sale of cannabis derivative products including vapes, edibles, concentrates, and beverages. Not long after, in December 2019, Aurora launched new lines of cannabis-infused edibles and some vape products.

But since then, the company has gone radio silent on the launch of any new products -- not a good sign. This is when Aurora should be pushing full tilt into the hot market for derivatives, which could boost its revenues considerably. One research report from Deloitte estimates that the cannabis derivatives market could be worth $2 billion Canadian annually. 

In its fiscal Q1, which ended Sept. 31, net revenue from Aurora's consumer cannabis extract products was up by CA$3.6 million thanks to the sale of higher-margin products (including cannabis derivatives), but it wasn't enough to bring the company into the black. In fact, using the adjusted EBITDA metric, it rang up a loss of CA$57.8 million, compared with a loss of CA$33 million in the year-ago quarter.

Management's efforts at reducing its selling, general and administrative (SG&A) expenses did have an effect; SG&A came in at CA$44.3 million, compared to CA$58.8 million in Q4. However, the company will have to cut costs further and boost revenue significantly to reach profitability, and that will only be possible if it launches additional, innovative derivative products that stand out in the market.

Rival Canopy Growth ( CGC 1.60% ) is already garnering positive reviews for its edibles, vapes, and cannabis-infused beverages in particular. The cannabis-infused beverage market has major potential in Canada, according to Deloitte, which estimates it could generate CA$529 million annually. And the U.S. cannabis beverage market could grow to be worth $2.8 billion by 2025, according to Grand View Research.

2. It lacks a deep-pocketed partner

The popularity of cannabis and the potential of the market has grabbed the attention of many U.S. tobacco and alcohol companies. Beverage giant Constellation Brands ( STZ 2.07% ) has a large investment in Canopy Growth, tobacco company Altria Group holds a stake in Cronos Group, and HEXO has a partnership with beverage company Molson Coors. However, Aurora Cannabis hasn't been able to land such a deal, which is worrisome.

The cannabis industry is still evolving, and a strong financial partnership with an established company not only would have kept Aurora's pockets full but also could have helped it increase its U.S. footprint. The global legal cannabis market could be worth $74 billion by 2027, according to Grand View Research, with estimates from New Frontier Data suggesting that the U.S. alone could generate annual revenue of $38 billion by 2025. The fact that no larger company has expressed interest in partnering with Aurora to go after these huge numbers demonstrates a general lack of faith in its business.

marijuana leaf made up coins

Image source: Getty Images.

In contrast, Constellation started with an initial investment of CA$245 million in Canopy in October 2017, and has been increasing its stake since then by exercising warrants -- a signal of its trust in Canopy's potential. Thanks to Constellation's investment, Canopy ended the quarter with CA$1.7 billion in cash and short-term investments that it can use to fuel its growth. The investment has also given investors greater confidence in Canopy. As of Nov. 29, its stock price was up 37.5% year to date. Meanwhile, Aurora's shares had lost about 59% of their value. The industry-tracking Horizons Marijuana Life Sciences ETF, meanwhile, was off by just 0.57%.

ACB Chart

ACB data by YCharts

3. It's failing to live up to its promises

This year, when Aurora started making drastic changes to its business, its main target was to achieve positive EBITDA by its fiscal fourth quarter, which ended in June. But it failed. Then, management said the company would achieve that goal by the second quarter of fiscal 2021. That period ends on Dec. 31, and I don't see it happening. Investors expected more from the new management team, which is led by CEO Miguel Martin. Martin previously served as CEO of Reliva, a seller of hemp-derived CBD products that Aurora acquired in May for $40 million worth of its common stock.

A disturbing pattern has developed here. In May 2019, management made similar assurances, saying the company was on track to achieve positive EBITDA by the fourth quarter of fiscal 2019. It failed, and its losses just kept increasing. Investors are understandably hesitant to trust in a management team that consistently misses its targets and appears to lack any clear plan for the future.

Its failure to launch more derivative products, its slow-growing revenue, an insufficiently urgent cost-cutting strategy, and the lack of progress under its new management team all add to my skepticism. It would be wise for investors to steer clear of this marijuana company until it shows some positive numbers. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Aurora Cannabis Stock Quote
Aurora Cannabis
ACB
$5.97 (2.58%) $0.15
Constellation Brands, Inc. Stock Quote
Constellation Brands, Inc.
STZ
$230.87 (2.07%) $4.68
Canopy Growth Stock Quote
Canopy Growth
CGC
$10.15 (1.60%) $0.16

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