Reality has set in and replaced euphoria in the marijuana industry. Investors now doubt if the cannabis producers can actually deliver profits as promised. The shares of Aurora Cannabis (TSX:ACB)(NYSE:ACB) has risen nearly 76% on the TSX from the year-end closing price. But the risk of volatility hasn’t diminished.
Aurora Cannabis reported an exceptional first quarter to handily outplay closest rival Canopy Growth (TSX:WEED)(NYSE:CGC). The company’s market cap is just 60% of Canopy’s, but leads in the production department by a mile. If that’s the case, how come hitting the home run this year is still unsure?
Share dilution In 2016, Aurora Cannabis went on a buying spree. The most notable among those is the buyout of ICC Labs in South America. Instead of paying in cash, the company paid via shares of stocks, convertible notes, warrants, and options. The sum total is one billion shares that dwarf the 16.2 million during its 2014 IPO.
With this scheme, share price valuation is difficult. It doesn’t sit well with investors. Aurora Cannabis is nothing more than a share dilution machine in a market that’s volatile and starting to bottom out.
Lower wholesale pricing Aurora Cannabis is in the best position to scale in legalized marijuana market. Hitting sales targets won’t be an issue. However, lower wholesale pricing presents a huge problem. To illustrate this, the price per gram of dried cannabis dropped 21% year-over-year, which dented Aurora’s bottom line in 4Q 2018.
Also, Aurora didn’t realize the supposed higher margins from extracts, but succumbed to a price drop 25%. The company is posting higher sales, but the revenue per transaction is meager. If the trend of lower prices persists, it would be a big strain for the company and the industry in general.
No big firm partner but an activist investor to spur growth Most of Aurora Cannabis’ competitors have partnered with big firms operating outside the cannabis sector. For its part, the company took in Nelson Peltz, founder of Triad Fund Management as a backer. This is not to belittle the track record of Peltz, however, who is known for turning companies around.
Still, the future success of Aurora lies squarely on Peltz’s shoulders. He might be the key to forge corporate partnerships that are missing so far. The strategic advisor needs to prove his mettle.
Another dilution move Aurora Cannabis just announced another round of raising capital through the issuance of common equity, debt, warrants, subscription receipts, or a mix of the mentioned securities. The company defends the move to raise US$750 million as a long-term strategic measure. This would have a dilutive effect again.
The bases are loaded yet Aurora Cannabis would likely miss hitting the home run this year. Investors can’t interpret or make out exactly the strategy of the industry’s largest producer.
Until people can arrive at a sensible valuation, investing in Aurora Cannabis is highly speculative and a risky play. The glaring risks are the red flags.
Fool contributor Christopher Liew has no position in any of the stocks mentioned.
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