Aurora Cannabis Ticking Time Bomb – Motley Fool

Aurora Cannabis\ Ticking Time Bomb - Motley Fool
How Does Investing In Aurora Cannabis Inc. (TSE:ACB) Impact The Volatility Of Your Portfolio?
Its been a wild ride for Aurora Cannabis (NYSE:ACB) so far this year. Analysts came out of the woodwork to recommend the stock early in 2019.

Aurora delivered sizzling revenue growth quarter after quarter. It brought billionaire investor Nelson Peltz on board to help line up partners from outside the cannabis industry. And Aurora accelerated its push to boost production capacity beyond the levels of all its rivals.

What’s the company’s strategy? It’s simply to roll-up the fragmented collision repair centre industry. After years of rapid growth, Boyd now controls 4% of the entire industry. Still, Boyd’s market cap is just $3.5 billion, while the industry at large is worth roughly $50 billion. That should provide plenty of additional growth, especially considering 80% of the industry consists of small business owners in local communities. Boyd stock has never had a losing year in its entire operating industry. I expect 2020 to be another banner year.

All of this helped fuel a meteoric rise for Aurora, with its stock more than doubling at one point. But then came the downturn, and analysts changed their tune about Aurora. The company over promised and under delivered on its fourth-quarter results. 

3 Marijuana Stocks Better Than Aurora Cannabis

Dont think the challenges for Aurora are over yet. The Canadian cannabis producer has a ticking time bomb on its hands that could cause more problems.

Pot stocks are in their longest-ever losing streak. Over the last 12 months, most cannabis ETFs are down roughly 50%. As with any bear market, the smallest competitors have gotten it the worst. Green Organic Dutchman Holdings (TSX:TGOD), for example, is down nearly 70%. The company’s market share has been reduced to just $630 million. While this stock carries its fair share of risk, there’s no denying that 2020 could be an explosive year for the company.

What is this ticking time bomb? Aurora has 230 million in Canadian dollars worth of convertible debentures that mature in March 2020. This debt offering closed two years ago and all the cash is gone. Aurora used the money primarily to fund its acquisition of CanniMed Therapeutics and toward the construction of the Aurora Nordic facility in Denmark.

Importantly, the company remains profitable, with revenues continuing to grow year after year. Management and analysts alike anticipate the company maintaining a long-term EPS growth rate between 20% and 30%. If this becomes reality, the current valuation is a steal. In five years, Canada Goose could realistically be earning $5 per share. At a discounted 25 times earnings valuation, that implies a share price of $125, representing 300% in upside.

By definition, convertible debentures can be converted to stock if the holders choose that option. But the conversion price for this particular debt offering was 13.05 Canadian dollars per share. Auroras current share price is less than half of that amount. No one will convert a debenture to stock at such a huge loss.

Canada Goose Holdings (TSX:GOOS)(NYSE:GOOS) is another former growth stock in the penalty box. After its IPO in 2016, the stock went on a 400% rise in less than 24 months. This year, shares have slid by 30% due to fears of slowing growth. After years of trading at 50-100 times earnings, the stock is now valued at just 34 times forward earnings.

Its possible that Auroras share price could skyrocket between now and March, alleviating the need to pay off the big debt. The company might receive a boost if it lands a major partner that will help it enter the U.S. hemp CBD market. Maybe the “Cannabis 2.0” cannabis derivatives market that launches soon could provide a major catalyst for Aurora. Dont hold your breath.

For one thing, Auroras management has been clear that the company isnt seeking an equity investment from an outside partner. As a result, any deals that Aurora makes could have a more muted impact than the big partnership deals for Canopy Growth and Cronos Group. Also, the Cannabis 2.0 market wont have a significant financial impact on Aurora until the company reports its fiscal 2020 Q3 results — and that will be after the looming convertible debentures maturity date.

In early September, Aurora Cannabis terminated its sourcing agreement with Green Organic, while liquidating the rest of its equity stake. Aurora had originally agreed to purchase 20% of Green Organic’s cannabis output. Without a cornerstone customer and investor, TGOD shares have been left for dead.

The odds appear to be overwhelmingly high that Aurora will need to muster up CA$230 million to pay off the holders of its convertible debentures that mature in March 2020. But where will the company get the money?

Aurora had CA$172.7 million in cash and cash equivalents on hand at the end of June. However, its a stone-cold certainty that cash will dwindle considerably between now and early next year. Aurora posted an operating loss of CA$44.6 million in its last quarter. While the company expects improvement, it wont be enough to avoid tapping into its cash stockpile throughout the rest of this year and into 2020.

It’s not difficult to find yesterday’s high-growth stocks. The problem arises when trying to find tomorrow’s high-growth stocks. Even worse, high-growth expectations are already baked into the price, meaning your upside will be limited.

That leaves Aurora with three primary alternatives for raising the cash needed to pay off the CA$230 million in debt. The companys options are to do one of the following:

I would recommend cannabis investors take a diversified approach and invest in at least four or five different stocks. I would include CGC stock and even ACB stock in that basket. ACB stock may not be the most attractive at today’s prices, but it is still a market leader in cannabis and is well-positioned to stay that way. CWBHF stock, GTBIF stock and TCNNF stock can also be included in that portfolio. But I would recommend allocating no more than 20% of your total cannabis investment to these smaller, more speculative plays.

It seems unlikely that Aurora will directly issue new shares since the company hasnt taken this path over the last couple of years. Chances are that it will instead either issue even more convertible notes, lean on its BMO debt facility, or do a combination of both.

Earlier this month, Aurora closed on an expansion of its debt facility with BMO. The company added CA$160 million in term loans to its original CA$200 million credit line and has the flexibility to increase the debt facility by around CA$40 million. All of this debt matures in 2021.

The unbridled enthusiasm that initially greeted many U.S.-listed marijuana stocks has died down. It has been replaced with a more pragmatic market view of the long journey the cannabis industry has ahead. It will take many years of heavy investments and political battles before the industry hits its full stride. In the meantime, investors will be looking for the best potential value in the space.

Investors shouldnt worry too much about Auroras ability to pay off its CA$230 million debt by March. However, depending on how the company chooses to repay that debt, it could mean that even more dilution is on the way. That is something to worry about.

ACB stock already benefited from the early rush of capital into U.S.-listed marijuana stocks and all of the bullish headlines that surrounded it. Now, the market is readjusting its valuation to a more appropriate level. At this point, the cannabis bull thesis is about which marijuana stocks can grow into their valuations fastest without diluting shareholders.

Aurora has been able to deliver impressive stock gains over the last few years, even as its diluted the value of existing shares like crazy. It might not be able to keep doing both for much longer.

In my opinion, CGC stock and ACB stock are high-risk, and they are the market leaders. CWBHF stock, GTBIF stock and TCNNF stock are all extremely high-risk. They are all much smaller players with much fewer resources. They all have uncertain regulatory outlooks. But Carroll makes solid arguments about why each stock is a buy.

The reality is that Aurora Cannabis keeps kicking the can down the road with its borrowing. Investing in marijuana stocks comes with plenty of risks, but a company thats up to its eyeballs in debt has even more risk than one with a healthy balance sheet.

With its steadily increasing debt, Aurora may be facing more time bombs ticking away that might not be as easy to defuse.

Some stocks are more sensitive to general market forces than others. Beta is a widely used metric to measure a stocks exposure to market risk (volatility). Before we go on, its worth noting that Warren Buffett pointed out in his 2014 letter to shareholders that volatility is far from synonymous with risk. Having said that, beta can still be rather useful. The first thing to understand about beta is that the beta of the overall market is one. Any stock with a beta of greater than one is considered more volatile than the market, while those with a beta below one are either less volatile or poorly correlated with the market.

Given that it has a beta of 1.94, we can surmise that the Aurora Cannabis share price has been fairly sensitive to market volatility (over the last 5 years). If this beta value holds true in the future, Aurora Cannabis shares are likely to rise more than the market when the market is going up, but fall faster when the market is going down. Many would argue that beta is useful in position sizing, but fundamental metrics such as revenue and earnings are more important overall. You can see Aurora Cannabiss revenue and earnings in the image below.

With a market capitalisation of CA$6.3b, Aurora Cannabis is a pretty big company, even by global standards. It is quite likely well known to very many investors. It takes deep pocketed investors to influence the share price of a large company, so its a little unusual to see companies this size with high beta values. It may be that that this company is more heavily impacted by broader economic factors than most.

Since Aurora Cannabis has a reasonably high beta, its worth considering why it is so heavily influenced by broader market sentiment. For example, it might be a high growth stock or have a lot of operating leverage in its business model. In order to fully understand whether ACB is a good investment for you, we also need to consider important company-specific fundamentals such as Aurora Cannabiss financial health and performance track record. I urge you to continue your research by taking a look at the following:

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.


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