When It Comes To Cannabis Plays, Stay Away From Aurora Stock

Management doesn't have a clear path to reducing ACB's debt

Marijuana has been a hot topic among investors this year as they speculate on whether the industry will see another big push after a dismal 2019. While I’d agree that marijuana is a sector worth considering for 2020, there are a lot of pitfalls within that space, and Aurora Cannabis (NYSE:ACB) is one of them.

Despite Aurora stock declining more than 80% over the past year, more downside could be on the horizon. 

Aurora Stock’s Debt Will Be Its Demise

While there are a few problems facing Aurora Cannabis, the firm’s balance sheet is its largest issue. This summer, the firm will have to answer to a 360 million CAD debt obligation in August of next year and several analysts have cautioned that ACB isn’t going to meet the covenants for that loan. 

Christopher Carey from Bank of America lowered his price target for Aurora stock to just 1.50 CAD saying, “with balance sheet risks to remain a core investment thesis in 2020 in our view, and lingering uncertainty especially on financial covenants, we struggle to envision a scenario where shares have sustainable support.”

He’s not alone either. Michael Lavery of Piper Sandler sees ACB share price heading to $1, citing risky financials. Lavery pointed out that one of Aurora’s loan covenants requires the firm to have a debt-to-EBITDA ratio below 4x by Sept. 30, 2020. Lavery doesn’t believe that will be possible until the back half of 2020.

How Will ACB Avoid Default?

It’s unclear exactly how Aurora’s management is planning to deal with its debt obligations. ACB spokeswoman Michelle Lefler told Bloomberg that the firm is considering every option at the moment. For now, most seem to be expecting Aurora to restructure that debt and negotiate changes to some of the covenants. 

Aurora’s management has said that cannabis product sales are expected to increase substantially over the next few quarters, which should help the firm with debt repayment. The firm said consumers’ response to Cannabis 2.0 products has been “fantastic,” pointing out that sales of edibles like gummies and chocolates came in above expectations.

Vivien Azer of Cowen echoed management’s confidence in a note to clients earlier in January. She noted that at the ICR Conference, Aurora’s team said it was working on debt restructuring deals, as well as a cost saving plan that will cut down on general and administrative expenses and capital spending in order to free up some cash.

Pablo Zuanic of Cantor Fitzgerald was similarly optimistic about Aurora’s future, saying now is a good time to pick up shares of Aurora stock and buy the dip. Zuanic said the firm’s partnership with Nelson Peltz adds to confidence that management will get implement a greater sense of financial discipline. 

Buying Opportunity or Falling Knife?

Much of the buy-case for Aurora stock depends on whether or not you trust that management can work its way out of this hole. For now, my answer to that is no. Perhaps the only saving grace for ACB is the fact that the firm has the highest production capacity in the industry, but that alone isn’t enough to repair its tattered balance sheet.

While management has been working on asset sales and cost savings, we have yet to see an actionable plan to pay down the firm’s massive debt pile. While Nelson Peltz’s notoriety as an investor and business man is certainly worth considering, that’s not necessarily a compelling reason to trust in Aurora’s future.

Last year some pointed to Peltz’s relationship with Aurora as reason to believe a strategic partnership with a big-brand was coming. However nothing of the sort ever materialized, and with the firm’s financials in such disrepair that prospect has become unlikelier still.

The Bottom Line On Aurora Stock

There’s certainly a speculative play to be made here if you think Aurora will be able to restructure its debt and generate enough cash to pay down its loans going forward. But it would be pure speculation— not something I’m comfortable with in today’s market. That’s especially true when it comes to the marijuana sector where the environment is inherently risky. I’d be willing to consider Aurora stock when it falls to $1 or if management can present a compelling strategic plan to get the firm’s finances back on track.

As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities.