You’d struggle to find an industry with more robust long-term growth potential than legal cannabis. Depending on your preferred source, the marijuana industry is capable of $50 billion to $75 billion in annual sales by the turn of the next decade, which would represent anywhere from 12.5% to 16.7% compound annual growth over a 12-year period, between 2018 and 2030. Good luck finding that type of growth in other industries.
The problem is, the secret is out. Gains in marijuana stocks have been astronomical since the beginning of 2016 as global legalizations have taken shape. Canada recently became the first industrialized country in the world, and only the second country overall behind Uruguay, to give the green light to adult-use weed, while 33 U.S. states and more than 40 countries worldwide have passed medical cannabis laws. It’s a burgeoning industry with a seemingly limitless ceiling for the time being.
Investors fall head over heels for this top pot producer
Among the dozens upon dozens of pot stocks that investors have to choose from, none is more popular than Aurora Cannabis (NYSE:ACB), especially with millennials. One reason Aurora hogs all the glory is that it’s slated to be the largest cannabis producer by peak production. Although management suggests that peak output will top 500,000 kilos, in my view, Aurora Cannabis should produce more like 780,000 kilos a year by 2022.
Aurora is also a company that’s done a very good job of pushing into overseas markets. The company has a distribution and/or production presence in 24 countries worldwide, which will come in handy if and when dried cannabis flower becomes oversupplied in Canada. With close to 840 applications in backlog (mostly cultivation applications), Health Canada could soon turn the country’s pot shortage into a massive glut. These external sales channels will be of the utmost importance to Aurora and help ensure that its margins aren’t decimated by falling per-gram flower prices.
The company’s focus on medical marijuana patients is also unique. Whereas most growers have leaned very strongly toward the recreational side of the equation, because the consumer pool is considerably bigger, Aurora has placed its focus on medical patients. The reason? Medical pot patients use cannabis more frequently, buy more often, and are more willing to purchase higher-margin alternative products, such as oils.
And yet, despite all of these advantages, there are some very good reasons to avoid this top-producing marijuana stock.
Five reasons Aurora Cannabis shouldn’t be on your buy list
One of the top reasons Aurora doesn’t fit the mold of an upper-echelon pot stock is the company’s cash situation. Subsequent to the end of its fiscal second quarter, ended Dec. 31, 2018, Aurora announced a 345 million Canadian dollar (CA$345 million) convertible note offering that, in combination with its cash and cash equivalents, brought its total cash holdings to around CA$500 million (close to $375 million). Unfortunately, given Aurora’s penchant for acquisitions, this still isn’t enough cash to give the company a lot of flexibility.
Building on this first point, Aurora’s lack of available capital often means that it turns to the secondary market to fuel acquisitions and capital. This is just a fancy way of saying that it issues common stock like Monopoly money, as well as using convertible debt to raise capital. Nearly all of Aurora’s capital raises will wind up ballooning the company’s outstanding share count, which ultimately hurts its long-term shareholders. Since the end of fiscal 2014 (June 30, 2014), Aurora’s share count has risen by more than 1 billion shares to 1.02 billion — and it’ll probably rise even more. In early April, Aurora announced a $750 million shelf offering that it can deploy as it sees fit.
Aurora Cannabis is almost certainly going to struggle to generate a meaningful profit, too. Despite management expecting positive recurring EBITDA (earnings before interest, taxes, depreciation, and amortization) beginning in the fiscal fourth quarter (April through June), Aurora appears to have little shot of generating recurring profits, without the aid of one-time benefits, until 2021. And even then, its per-share profit could be marginal for years to come, thanks to the ridiculous number of shares the company has issued since the end of fiscal 2014.
Let’s also not forget that Aurora Cannabis is one of the few marijuana stocks without a partner right now. Some would view this quest for a brand-name partner as another catalyst that could shoot Aurora’s stock higher. However, I’d note that Aurora’s lack of a partner could be a result of no brand-name companies wanting to take an equity stake in a company that would continually dilute their stake with share-financed acquisitions.
Lastly, there are concerns about Aurora’s numerous acquisitions. While goodwill — i.e., essentially the amount of premium paid, above tangible assets, that an acquiring company recognizes on its balance sheet — is a normal part of the acquisition process, no pot stock is sporting more goodwill as a percentage of total assets than buyout-hungry Aurora. At the end of the second quarter, it had CA$3.06 billion in goodwill, representing 63% of its total assets. There are simply no guarantees that Aurora will recoup this goodwill anytime soon. In fact, it could make Aphria‘s recent acquisition writedown look like child’s play.
Aurora may be a popular marijuana stock, but that doesn’t make it a good investment.
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