It's been roughly five years since Canada legalized cannabis, and it's been an unpleasant ride for investors in Aurora Cannabis (ACB -6.81%), one of Canada's leading growers and operators.
The company became a penny stock after surging to over $120 per share in 2018. While some may hope for a tremendous comeback story, sometimes a business model just isn't good.
Here's a look at Aurora Cannabis' problems and why investors should stay away from the stock for the foreseeable future.
Cannabis became a commodity
There was a lot of excitement when Canada legalized cannabis; a new market was born. However, the enthusiasm created a rush of companies flooding the market -- and with it, competition.
You can see in the chart that Aurora's gross margins and revenue growth were strong initially, but operators had to cut prices to compete as supply increased.
ACB Gross Profit Margin data by YCharts
When a company's margins go from north of 50% to negative in a few years, that's a sign that the business has little competitive advantage. Although there are differences in types of cannabis flower, what's the difference between brand X and brand Y? The black market, which supported demand for years, had no branding. Facing pricing pressure while a company invests in growing production, marketing its product, and hiring employees is a recipe for financial disaster.
Data source: Aurora Cannabis.
You can see that gross profit was just 3.5 million Canadian dollars over the last six months of 2022, leading to tremendous losses once you factor in overheads and other expenses. Without pricing power, Aurora Cannabis must sell a ton of volume to generate cash flow, which it hasn't been able to do yet.
How long can Aurora survive?
Aurora must stop burning cash if it wants to survive over the coming years. It turned a profit on non-GAAP (generally accepted accounting principles) earnings before interest, taxes, depreciation, and amortization (EBITDA) in its quarter ending Dec. 31, but that doesn't translate to cash flow. Balance sheet cash declined to CA$310 million from CA$488 million the prior quarter, and operating losses were CA$71 million for the quarter.
Management is aggressively cutting costs, but it's still hard to see its cash position lasting much longer. Without significant improvements, Aurora has enough cash for another year at last quarter's burn rate. The company could be forced to raise cash with an equity raise (a very dilutive move at its current share price), meaning the stock would be worth even less.
On the other hand, Aurora has been trying to stabilize its balance sheet, and taking on new debt to survive would also be counterproductive. Aurora's management called its efforts to turn cash flow positive a multiquarter initiative, which doesn't instill much confidence that it can do so without an injection of funds.
Don't get lured into a penny stock
Aurora's share price has declined to less than $1, making it a penny stock and an extremely speculative investment. Don't get tempted into making a bad investment by looking for an easy gain. The stock is this cheap because Aurora faces a real chance of bankruptcy and could struggle to make it much further than 2024 at this rate.
The company was once a promising player in a growing cannabis market, but a mixture of bad management and pricing pressure on a product that sells like a commodity stopped Aurora in its tracks. Avoid the stock until the business is at least generating an operating profit, and then reassess from there. Otherwise, your hard-earned money could go up in smoke.
