Why We Are Short Aurora Cannabis

Aurora Cannabis (NYSE:ACB) has always been one of the big three Licensed Producers (LPs) in Canada (along with Canopy Growth and Aphria). They have one of the largest cultivation capacities and an extensive global footprint. They are extremely well-positioned to capitalise on the growing Canadian recreational market, and with the release of edibles and extracts, should continue to see their status as one of the largest suppliers to this market steadily increasing.

However, their high levels of spending and massive Capex intensive projects, coupled with a very weak and shaky balance sheet, make Aurora one of the riskiest stocks for 2020. This was emphasised with the sudden departure of the "face" of the company, and globally-recognised, industry-leader, Cam Battley in December last year.

The Good

Aurora is based in Edmonton, Alberta, and while the company currently has operations on five continents, almost 95% of its sales come from the Canadian market. Aurora has one of the largest cultivation capacities of any of the Canadian LPs. Aurora Sky, the company's 1m square foot facility just outside of Edmonton airport, is one of the world's most technologically advanced greenhouses and is capable of producing up to 100,000 kilograms of cannabis per annum.

Given the high levels of technology and automation, the company is able to produce cannabis on a very large scale, at a very low cost per gram. Given the low cost of production, Aurora is able to deliver some of the highest gross margins in the industry. 

Aurora Cannabis Gross margins v Peers
Source: Company Filings

At 56% gross margin, only Aphria and Organigram (at 50%) come even close. These gross margins and low production costs have positioned Aurora to take advantage of the growing recreational market, which is estimated to be about 4-5 times larger than it currently is in the coming 5 years. However, that's where the positives end, and the negatives begin. And the negatives far outweigh the positives.

The Bad

Aurora's massive spending has led to very poor levels of profitability and cash flow.  This capital crunch has necessitated the company to put a halt to some of the cultivation projects currently under construction. In the past 12 months, the company has burned over CAD$200 million in operating cash flow, and over CAD$450 million on capital expenditures. This means that in the past year, the company has burned nearly CAD$700 million. That's worth repeating – nearly CAD$700 million!

As of June 2019, Aurora had $237 million in the bank, with its debt ballooning to a staggering CAD$800 million. This situation meant that the company had only one quarter's worth of funding left. The cash crunch was even addressed in their recent September quarterly announcement.

The company could not afford to repay the debt as the conversion price was at a stratospheric $13.05 per share. Given this price and the cash crunch, the company had no option but to settle the debt in exchange for equity. In mid-November 2019, the company offered all noteholders the option to convert the debt to equity. $227 million was converted to debt, however this came at the expense of a 7% dilution to existing shareholders

Aurora Cannabis Aurora Sun Facility
Aurora Sun

The Disappointing 

In order to stop the cash rot, the company has placed a hold on the completion of its production and cultivation facilities, which are still under construction. They halted work at Aurora Sun and Aurora Nordic 2, and have listed for sale facilities that combined could produce over 100,000 kilograms per annum. In addition to the above, Aurora is also selling its greenhouse in Exeter, which it received as part of its acquisition of MedReleaf in 2018.

Aurora would need to spend significant Capex to complete the above facilities with estimates indicating that Aurora Sun would require over $100 million to complete, while Aurora Nordic 2 needs another $80 million. Growth is now on hold.

And the Ugly 

In December last year, Cam Battley stepped down from his role as Chief Corporate Officer, with immediate effect. One of the factors that would seem to be behind this departure is the fact that – due to the cash crunch – the company is scaling back the expansion of its global operations and taking a massive write-down on many of its acquisitions. Put bluntly – the company simply cannot afford to run global operations, and given this, it makes Battley's role a little redundant.

Still, and let's be crystal clear on this – anytime a senior executive (who has been with the company since 2016) departs, it is a massive red flag for investors, and in this case – the red flag is justified.

Disclaimer: Past performance is not an indicator of future performance.

The Bottom Line

Aurora Cannabis is a company investors should avoid for the moment. Even with the massive decline in share price over the past couple of months, we still believe the company to be bloated and overvalued. With the Canadian recreational market still in its teething phase, and not showing anywhere near the kind of growth that was estimated and expected, it is difficult to see how Aurora is going to ramp up revenue in the coming quarters.

Unless Aurora can increase their revenue significantly, and with their current cash balance and extreme levels of debt, the company is going to have to tap the capital markets again, ultimately leading to downward pressure on the share price and significant, ongoing, shareholder dilution. Even at these depressed stock levels, we are still short on Aurora and would suggest investors stay well away.

This could be one of the best investing opportunities of 2020

Legislative changes are blowing through the US, and with it, an ever-increasing number of states legalising cannabis for recreational use.

With the success seen in Illinois, which legalised for adult-use on January 1 and saw products moving off the shelf at an unprecedented rate, this company is primed to take advantage of the booming US recreational market.

They have secured partnerships with the biggest cannabis companies in the US, and their portfolio is second to none.

And with the sector-wide pullback of 2019, this company is now at a bargain-basement price.

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Mark Bernberg
Mark Bernberg

Mark Bernberg is a long-time cannabis investing enthusiast and founder of The Green Fund, Asia Pacific's preeminent media house, positioned at the forefront of the global cannabis industry.

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