Aurora Cannabis moet vechten om te overleven, niet om groei te stimuleren


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Initiating Coverage

I am initiating coverage on Aurora Cannabis (ACB) with a “Neutral” outlook.

At the onset, I want to pretend as an investor who has never tracked the stock of Aurora Cannabis. The investor opens the February 2020 presentation of the company and notes the following points:

  • Aurora Cannabis is earning its leadership position in a $200 billion industry
  • The company currently has a production capacity of 150,000 kilograms per year of dry cannabis
  • The company has sales and operations in more than 20 countries with a leadership position in Canada
  • The company has robust investments in R&D with 108 patents filed-to-date

This certainly makes me excited. The company has a total addressable market of $200 billion and seems to be pursuing rapid global expansion.

When I look at the stock price of this potentially high growth company, it touched a high of $10.32 in March 2019. Since those highs, the stock has plunged by 89% to $1.17.

I am initially perplexed. But a deeper investigation leads to the conclusion that Aurora Cannabis should be avoided even after the big plunge. Sure, there can be trading bounce back from oversold levels, but Aurora Cannabis is still not a long-term investment stock.

This initiating coverage will discuss the factors that will translate into relatively sluggish growth for the company and hence makes the stock unattractive.

Medicinal Cannabis Growth Will Remain Sluggish

For Aurora Cannabis, there are two broad business segments – Medicinal and Recreational cannabis.

In the medicinal cannabis segment, I believe that top-line growth will remain muted for the coming years. Growth in the medicinal cannabis segment has already been disappointing.

For the quarter ended September 2019, the company reported medicinal cannabis revenue of $30.4 million. For the quarter ended December 2019 (Q2 2020), medicinal cannabis revenue declined to $27.4 million.

For an industry at an early growth stage, quarter-on-quarter decline in revenue is disappointing. Even on a year-on-year basis, there is nothing exciting to talk about in terms of growth.

However, a more important discussion is the reason why medicinal cannabis revenue will remain weak in the coming years.

I want to start with what the U.S. Food & Drug Administration has to say on medicinal cannabis. According to the FDA:

To date, the FDA has not approved a marketing application for cannabis for the treatment of any disease or condition. The agency has, however, approved one cannabis-derived drug product: Epidiolex (cannabidiol), and three synthetic cannabis-related drug products: Marinol (dronabinol), Syndros (dronabinol), and Cesamet (nabilone). These approved drug products are only available with a prescription from a licensed healthcare provider. Importantly, the FDA has not approved any other cannabis, cannabis-derived, or cannabidiol (CBD) products currently available on the market.

The FDA further states the following:

FDA is aware that unapproved cannabis and/or unapproved cannabis-derived products are being used to treat a number of medical conditions including, AIDS wasting, epilepsy, neuropathic pain, spasticity associated with multiple sclerosis, and cancer and chemotherapy-induced nausea. However, the use of unapproved cannabis and cannabis-derived products can have unpredictable and unintended consequences, including serious safety risks. Also, there has been no FDA review of data from rigorous clinical trials to support that these unapproved products are safe and efficacious for the various therapeutic uses for which they are being used.

These statements from the FDA are enough to elaborate on the reason for medicinal cannabis growth remaining sluggish.

For now, the medicinal products by Aurora Cannabis or any other cannabis company are largely based on claims. This is unlikely to boost consumer confidence or the confidence of doctors to recommend these products.

I can say that Aurora Cannabis is moving in the right direction. The company has 40 clinical studies underway, 7 pre-clinical studies, and 27 clinical studies under discussion. However, even if these studies are successful, it will be a few years before further FDA approval is received.

During this period, Aurora Cannabis will continue to face cash burn and additional funding for R&D. Therefore, I don’t see the cash burn ending anytime soon. This implies equity dilution, which is negative for the stock. It is for this reason that I believe that Aurora Cannabis should focus on survival than push for growth in multiple countries.

Coming back to the medicinal cannabis outlook, the U.S. has granted $3 million to “fill gaps in medical marijuana research.” According to Dr. David Shurtleff, deputy director of the National Center for Complementary and Integrative Health – “The science is lagging behind the public use and interest. We’re doing our best to catch up here.”

These observations clearly point to the fact that the medicinal cannabis segment needs more funding and research before its adoption accelerates. This also explains the reason for the stock sliding by 89%. Initially, the stock surged due to irrational exuberance considering the total addressable market. However, the reality is being discounted in the valuations. Big growth is years away and subject to research approvals.

Headwinds Exist Even For Recreational Cannabis

I am focusing on the research aspect of cannabis in this initiating as consumers are more informed and purchase decisions will be impacted by observations by FDA, among others.

I believe that top-line growth will disappoint even in the recreational cannabis segment. Even if growth is healthier as compared to medicinal cannabis, it’s unlikely to be enough to trigger the stock upside.

The recreational cannabis is important to discuss since the company has launched Cannabis 2.0 products in December 2019. These products include vapes, concentrates, gummies, chocolates, baked goods, and mints.

If we look at what the FDA has to say, the authority warned 15 companies in November 2019 for illegally selling various products containing cannabidiol. Further, according to the FDA:

Based on the lack of scientific information supporting the safety of CBD in food, the FDA is also indicating today that it cannot conclude that CBD is generally recognized as safe among qualified experts for its use in human or animal food.

While Aurora Cannabis is launching products like gummies, chocolates, baked goods and mints, the FDA is uncertain on the safety of these products. I am not suggesting that people will not consume these products. Even tobacco is harmful and consumed widely. All I am suggesting is that growth is likely to be hindered.

According to the National Institute of Drug Abuse:

THC is able to alter the functioning of the hippocampus and orbitofrontal cortex, brain areas that enable a person to form new memories and shift his or her attentional focus. As a result, using marijuana causes impaired thinking and interferes with a person’s ability to learn and perform complicated tasks.

The reason for highlighting these factors is also to underscore the point that recreational cannabis expansion in multiple countries is likely to face regulatory headwinds.

Overall, recreational cannabis growth can be faster than medicinal cannabis, but it might not be enough to attract renewed investor attention.

Some Thoughts on Cash Burn

In my view, the next few years will determine the players who survive the current phase of cash burn. The coming years will not determine the market leader, but the market survivors.

For Aurora Cannabis, the company reported EBITDA loss of $119.9 million for the six months ended December 2019 as compared to EBITDA loss of $112.3 million for the comparable December 2018 period. Therefore, EBITDA losses have widened and annualized EBITDA loss is at nearly $250 million.

Further, the company’s cash used in operations for the six months ended December 2019 was $230 million. This implies an annualized cash used in operations of $460 million.

As of December 2019, Aurora Cannabis reported cash & equivalents of $156 million. Considering the rate of cash burn, Aurora Cannabis would need funding to continue the business. The cash burn concern is another key reason for the stock declining sharply.

Since profitability is still years away, Aurora Cannabis needs to focus on limited geographic regions and preserve cash than ramp-up selling & marketing efforts. The focus should be on investing in clinical trials and research. This will add credibility to the company’s products and trigger sales growth.

Concluding Thoughts

Aurora Cannabis faces multiple headwinds that include sustained cash burn, dilution concerns, slow top-line growth, and regulatory headwind. These factors are likely to keep the stock depressed.

There can be trading opportunities, but Aurora Cannabis is far from being a portfolio stock.

I, therefore, remain “Neutral” on Aurora Cannabis even after an 89% downside in the last one year.

It remains to be seen if Aurora Cannabis can survive an extended period of cash burn. I see significant cost cutting in the coming quarters in this fight for survival.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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