When it comes to cannabis stocks, there's always a few turnaround plays that might be tempting targets for investment. As the marijuana industry grows globally, more than a couple of companies have overextended themselves by building so much output capacity that they outpaced demand. While it's a bit of a gamble, these competitors just might be a bargain, especially if they can effectively scale back their operations.
In particular, Aurora Cannabis (ACB 1.44%) and Hexo (HEXO +0.00%) are two underperforming companies that are working to reposition themselves to become more stable and successful. Neither of these stocks are for the faint of heart, but let's investigate each to see if they could be worth a contrarian buy.
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Can Aurora follow through on its transformation plan?
Aurora Cannabis has been struggling for quite some time, and it's in the midst of an ambitious business transformation plan that aims to slash its costs and right-size the company. So far, there has been some noteworthy progress. To date, it has realized CA$33 million in annual cost savings out of an estimated total of up to CA$80 million.
That's sure to help its CA$375.27 million in cash stretch a bit further, which will be necessary. Quarterly revenue shrank by more than 11% in Q1 of FY 2022 to reach CA$237.77 in trailing sales; reaching profitability through a high rate of growth isn't looking feasible.
Management claims that Aurora will become profitable in the first half of FY 2023. But I'm not convinced that will happen yet. In the most recent quarter, Aurora's gross margin rose by only 1% even when making accounting concessions to adjust for fluctuations in the cost of cannabis. Aurora's net profit margin is deeply in the negative at -250%, meaning that it's still generating deep losses every quarter.
While the company is painfully and slowly working toward profitability, shareholders have a few points of consolation. First, Aurora is the largest player by revenue in the Canadian medicinal market. With that share, it managed to grow the segment's net revenue by 23% year over year, reaching CA$41 million. And its international medical segment grew by 146% year over year in the most recent quarter.
Still, moving forward it'll need to keep reducing its costs and increasing its revenue to have a chance at paying down its debt of CA$406.78 million.
Hexo is growing, but will it be enough to stay solvent?
With a fresh CEO and a handful of revenue-bearing acquisitions in the bag during 2021, things may be looking up for Hexo, provided that it can find a way to survive the next 12 months. Compared to a year ago, its total net sales grew by 43% in the fourth quarter, and there should be more to come.
Last August, Hexo bought the Canadian cannabis company Redecan for CA$400 million in cash and CA$214.04 million in stock, which made it into one of the largest operators in Canada by adult-use market share. But Hexo issued around 69.7 million in new shares for the transaction, and the cash outlay left it with little liquid capital in reserve.
To its credit, management has been candid about the fact that the company doesn't have enough cash on hand to pay off its looming debt obligations while also continuing to invest in scaling up its operations. So shareholders should expect to have their equity diluted -- assuming Hexo doesn't put its growth plans on hold or work out a new arrangement with its lenders, which it has already done once.
None of those options sound very enticing for the prospects of a new investment, to say the least. If Hexo can find a way to become more profitable while getting the capital it needs, it'll pull through for investors, but I wouldn't bet on it as of now.
You probably shouldn't buy either of these stocks
Neither of these companies are in good shape, and they haven't performed well for their shareholders. Nor will the challenges of next year be gentle on either of them.
If you are heart set on buying one of the pair, opt for Hexo, because its revenue is growing rapidly despite its issues. But investors should be aware that Hexo could struggle even more if it can't find more cash to keep operating in the near term.
