The Top Marijuana Stock to Avoid In a Market Crash

If you had invested $10,000 in Aurora Cannabis (NYSE: ACB) just a year ago, your initial investment would be worth a meager $851 as of Sep. 29. Canada’s nationwide legalization of marijuana in Oct. 2018 was supposed to bring sweeping success to the country’s pot companies. However, Aurora grossly overestimated […]

If you had invested $10,000 in Aurora Cannabis (NYSE: ACB) just a year ago, your initial investment would be worth a meager $851 as of Sep. 29. Canada’s nationwide legalization of marijuana in Oct. 2018 was supposed to bring sweeping success to the country’s pot companies. However, Aurora grossly overestimated the market demand for cannabis, and invested billions of dollars in production facilities that never took off.

Not only did Aurora get its market dynamics wrong, but management of its existing capital will probably cause more woes for investors in the future. Let’s dig into why Aurora is the marijuana stock to avoid in the event of another market crash.  

Man refusing a joint.

Image source: Getty Images.

Financial missteps 

In 2019, Aurora issued more than 431 million shares in order to acquire competitors including MedReleaf, Anandia, and Agropro. The company ultimately paid inflated prices for these assets and had to write off over CA$1.6 billion in goodwill as their fair value declined. Due to severe oversupply, Aurora’s dried cannabis now sells for only CA$3.6 per gram as of the fourth quarter 2020, down 22% from CA$4.64 just one quarter earlier.

Aurora had to perform a 1-12 reverse stock split in May. This split was necessary in order to get Aurora’s share price back above $1 and avoid delisting from the New York Stock Exchange (NYSE). As of June 2020, the company had 115 million shares outstanding. The company’s shares outstanding last year, pre-split, were about 84.8 million. In other words, Aurora diluted its shareholders by about 35% in a matter of one year.  

That habit of issuing stock to eat up losses isn’t likely to disappear anytime soon. During the fourth quarter 2020, the company’s revenue decreased by 24% year over year to CA$72.1 million. Aurora’s gross margins fell from 58% in fourth quarter 2019 to 50%. Its cash use during the quarter was a staggering CA$100 million, with notable expenses such as CA$67.7 million in selling, general, and administrative expenses (SG&A) and CA$16.4 million in capital expenditures.

Unfortunately, Aurora only has CA$162.2 million left in cash to offset CA$83.7 million in loans and CA$294.9 million in liabilities for convertible notes. Since it is not profitable, Aurora may have to continue sacrificing shareholders’ capital in order to keep the company running. After June 30, Aurora raised $36.6 million in a new stock offering. 

Weed market chaos 

Aurora is ironically having a hard time adjusting to the post-legalization operating environment. Last November, the company predicted it would produce 700,000 kilograms (kg) of cannabis by mid-2020. In its quarter ended June 30, Aurora sold just 16,750 kg of the more than 44,400 kg it harvested. At the same time last year, the company sold 36,628 kg, representing a 52% year-over-year decline in production capacity.

There are various reasons for the sector decline. The black market’s sales have historically topped legal sales until this summer, the pandemic has kept consumers away from Aurora’s products, and more competitors have entered the industry now that weed is legal nationwide. But the fact that Aurora was overly aggressive in conducting acquisitions is the main reason for its collapse in revenues and earnings. 

As the price of dried cannabis declines in Canada, Aurora is simultaneously dealing with an oversupply of biological assets. The company continues to build up restructuring expenses so significant that it is difficult to see how Aurora can turn around its operations. Keep in mind, Aurora still has CA$139.2 million worth of marijuana inventory on its balance sheet. Ramping up production will only help the company once it has been unable to sell what it has already produced. In the fourth quarter alone, Aurora suffered a CA$86.5 million impairment charge due to production facility closures, and a stunning CA$135.1 million writedown to inventory it can’t sell.

ACB Chart

ACB data by YCharts

Takeaway for investors

Although the stock is trading for just 2.3 times price-to-sales (P/S) at a $570 million market cap, it is more likely to be a value trap than a hidden gem. Don’t be surprised if the stock reaches as low as 0.5 times sales. Regardless of whether or not the ongoing correction turns into a market rout, cannabis investors should get out of Aurora while they still can. 

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Zhiyuan Sun has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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