2023-06-01 05:50:23 ET
Summary
- Aurora Cannabis faces poor profitability and a challenging path to national legalization in the United States, leading to a strong sell rating.
- The cannabis market is highly competitive, with supply and demand imbalances causing price fluctuations and regulatory challenges.
- Aurora Cannabis has a highly leveraged capital structure and poor profitability, with a total return on assets of around -171%.
On the basis of poor profitability and a tough path to national legalization in the United States, I rate Aurora Cannabis ( ACB ) a Strong Sell in line with Seeking Alpha Quant . After reviewing market headwinds and recent research on the possibility of cannabis as a legitimate treatment, I discuss The United States government's position regarding cannabis. I then review the financials of ACB and develop a price target based on book value.
Cannabis Market
I begin by examining competition in the cannabis market, supply and demand dynamics, and regulation.
Competition
ACB is one of many players in the cannabis market. There is a laundry list of other cannabis names in the U.S. stock market. These include Trulieve Cannabis Corp. ( OTCQX:TCNNF ), Tilray Brands, Inc. ( TLRY ), Cronos Group ( CRON ), Canopy Growth Corporation ( CGC ), Curaleaf Holdings, Inc. ( OTCPK:CURLF ), and Green Thumb Industries Inc. ( OTCQX:GTBIF ), among others. There are also a number of ETFs available to cannabis investors, the largest being AdvisorShares Pure US Cannabis ETF ( MSOS ), with $349.42 million in AUM at the time of writing. The majority of its investments concentrate in Curaleaf and Green Thumb.
I list these names to highlight the fact that there is a wide variety of public companies and investment instruments available in the cannabis market. Any one stock in this space must really shine to stand out from the whole bunch, and when I discuss the financials of ACB, it clearly does not stand out in a good way.
Supply and Demand
According to the United Nations Office on Drugs and Crime , an estimated 209 million people used cannabis worldwide in 2020, the latest year with reliable data available. It is hard to find a good estimate on the total output of cannabis, but The National Cannabis Industry Association and Whitney Economics estimate a total supply of over 48.8 million pounds in the United States alone, including all forms of cannabis, illegal and legal. The report forecasts a shift in demand away from illegal to legal cannabis, and points out that some states are already suffering from an imbalance in supply and demand, with prices falling. This is good for the government in one way, as it makes the legal option more competitive on price and increases sales volume. However, less supply increases prices, and also increases tax revenue. Governments are thus taking data and weighing the optimal amount of cannabis supply taking into consideration a whole vector of variables.
Regulation
Legal cannabis is highly regulated. The rationale for legalization is almost entirely financial. There is a socially optimal level of cannabis use, as there is a socially optimal level of pollution. High tax rates and licensing fees deter industry entry. Only those who really want it, at their peril, may enter as a producer or consumer.
From a public health stance, the government couldn't be more clearly against cannabis. According to the CDC , "Recent research estimated that approximately 3 in 10 people who use marijuana have marijuana use disorder. For people who begin using marijuana before age 18, the risk of developing marijuana use disorder is even greater. Marijuana use directly affects the brain, specifically the parts of the brain responsible for memory, learning, attention, decision-making, coordination, emotion, and reaction time. Infants, children, and teens (who still have developing brains) are especially susceptible to the adverse effects of marijuana. Long-term or frequent marijuana use has been linked to increased risk of psychosis or schizophrenia in some users." My speculation is that legalization generates a quick buck, not stimulates an entire industry, as the latter is in nobody's best interest.
Financials
ACB is a highly leveraged company with poor profitability. While it may look like a good value, the price is highly discounted for good reason.
Capital Structure
Looking at the chart below, you see two good things and one bad thing. Cash and equivalents have risen steadily, and debt has been paid down from its peak around $480 million. Shares outstanding, however, have steadily risen. It thus appears that ACB has generated cash by selling equity to pay down debt, and seemingly hasn't done much with its cash other than pay off some debt.
Despite raising cash, ACB has mostly been decreasing its investments in capital expenditures, likely because it is operationally unprofitable, as I will show in the next section, and it therefore makes no sense to scale operations.
Profitability
ACB has a total return on assets of around -171%. That means it loses almost triple its book value each year from operations. It's not that the Company is aggressively depreciating assets to save on taxes: EBITDA margins are quite negative as well. It loses 187% of what it earns in EDITDA. There are several key costs shown below that are driving these losses.
ACB spent years with SG&A alone greater than revenue. Only in recent years has it cut down SG&A expenses, although the downtrend appears to have flatlined around $150 million. It loses almost $1 million per employee and negligibly spends on R&D. COGS has only recently crossed below revenue, meaning this company has operated at negative gross margins for some time. It just figured out how to cultivate marijuana at a cost less than the price at which it can sell it. For a brief period, either SG&A or COGS alone was greater than revenue. To me, that is a first, and these facts are staggering.
Valuation
Seeking Alpha Quant actually gives this name a grade "A-" valuation. It trades at around 40% of book value and sector median sales ratios based ironically on the Healthcare sector make it look good. Considering the steep losses this company incurs, I value it simply on its book value per my best estimate of fully diluted shares outstanding.
Total assets amount to $756.2 million. Total liabilities total $316.7 million. Given the recent trend of diluting shareholders to finance losses, I take the 341 million shares outstanding and assume it quadruples again in the next three years, a rough continuation of the current trend.
I therefore calculate a three year price target of $.43.
Conclusions
If you are going to invest in cannabis, which I suggest you do not, stay away from ACB. The company is highly leveraged and selling stock at a rapid pace to finance its losses. It is in a highly competitive and highly regulated market where the government stands to win more than any other player. The headwinds are taking a toll on operations. I would also recommend against a short position, as short interest is already quite high and a small amount of capital could cause a short cause in this name. Cannabis stocks are highly sensitive to news, and can make quite irrational movements when Congress just entertains the idea of legalizing cannabis. When it comes to Aurora Cannabis, "Just say no."
For further details see:
Aurora Cannabis: Highly Leveraged Capital Structure, Poor Profitability