I have maintained a “Bearish” view on most of the cannabis stocks in the last few months. My view has been backed by factors of cash burn, lack of clinical research and regulatory hurdles for industry players. There are still no compelling reasons to consider exposure to Aurora Cannabis (NYSE:ACB), even with ACB stock sliding by 75% from the highs of 2019.
As I scroll through the company’s presentation, Aurora Cannabis talks about a CAD$70 billion global market opportunity for medicinal cannabis.
On the other hand, the U.S. Food and Drug Administration has issued warning letters to 15 companies. The reason is “for illegally selling products containing cannabidiol in ways that violate the Federal Food, Drug, and Cosmetic Act.”
The FDA also mentions that it “has not approved any CBD products other than one prescription human drug product to treat rare, severe forms of epilepsy.”
The bottom line: Most of the medicinal cannabis products in the market are based on claims than clinical research-backed evidence. With the FDA having a strong oversight, it is unlikely that the medicinal cannabis industry will grow anytime soon. The “assumed” $70 billion medicinal cannabis market is therefore significantly delayed.
It’s not all gloom, a recent study has shown that a derivative of cannabis can be useful in the treatment of metastatic pancreatic cancer. There will gradually be progress in medicinal cannabis, but cannabis stocks will have an extended period of cash burn.
More Equity Dilution Likely
Another reason to be bearish on Aurora Cannabis stock is the equity dilution factor. For the first quarter of 2020, Aurora Cannabis reported cash & equivalents of CAD$152 million.
For the same period, the company’s cash used in operations was CAD$95 million. This implies an annualized cash used in operations of nearly CAD$400 million. Therefore, if this rate of cash burn sustains, Aurora will need to raise funds through equity dilution or leveraging.
Aurora Cannabis also seems to be more in-sync with the ground reality than before. The company has ceased construction activity at its Aurora Nordic 2 facility in Denmark. This will result in CAD$80 million savings over the next year. With a glut of dry cannabis and cannabis oil, it makes sense to postpone expansion activities and reduce cash burn.
However, it does not imply that Aurora can generate profit at EBITDA level. With the introduction of value-added products like vape pens and edibles, investment in selling & marketing will remain high.
In addition, R&D expenses will remain high as the company tries to introduce more value-added products. Therefore, the company will remain free cash flow negative and dilution is likely to take Aurora stock lower.
Recreational Cannabis and ACB Stock
In December, Aurora Cannabis will roll-out of vapes, concentrates, and edibles. Within edibles, the company plans to launch gummies, candies and baked goods. The company expects these products to boost margin and hence reduce cash burn.
However, recreational cannabis also faces high regulatory risk. As an example, The Centers for Disease Control and Prevention is investigating 193 potential cases of severe lung illness associated with e-cigarettes. If there are clear conclusions on the harmful effects, it can impact the growth of vapes.
My key point is that there are several risks related to cannabis and this will translate into regulatory headwinds. Only evidence-backed research can provide clarity and that will only happen gradually.
My Final Verdict on Aurora Stock
For a stock that has declined by 75% within one year, it might seem tempting to consider exposure. Temporary bounce back from oversold levels can’t be ruled out, but Aurora stock is still unattractive from a long-term perspective.
With prospects of sustained cash burn and continued equity dilution, Aurora stock is likely to remain sideways to lower.
The positive is that Aurora has 40 clinical studies that are underway or completed. The company is therefore moving in the right direction in terms of evidence backed entry in the global medicinal market. However, investors need to wait patiently with the initial exuberance related to cannabis stocks completely fading away.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.