Is Aurora Cannabis (NYSE:ACB) stock is so overvalued it is likely to drop 90% to its tangible book value? I argued last month that the cannabis grower was in bad financial shape, but last week, another market pundit came out with an even-dire assessment of ACB stock.
In his recent, well-thought analysis, Seeking Alpha contributor Robbert Manders set out the massive downside narrative on ACB stock, seeing oversupply crushing Aurora Cannabis’ market.
His analysis surprised me, even after my article last month. But I was impressed with the Dutch analyst’s logical take on the current cannabis market in Canada, showing a 90% drop from current levels is a very real possibility. That big of a fall would take the ACB stock price down to the level of Aurora’s existing tangible book value.
In other words, there is no compelling reason why ACB stock is still selling for 10x its tangible book value today. Especially since Aurora Cannabis is essentially just a large farm operation. It has no upside since it does not sell higher-margin products up the vertical supply and market chain.
Oversupply and Cheaper Illegal Cannabis Product
A key point that Manders makes about Aurora is that the company is just a large farm. So ACB operates in the commodity end of the cannabis market. He points out that there is no inherent reason why a farm should be so highly valued, even at today’s prices. ACB stock has already fallen 63% from its November 2018 peak.
Moreover, Manders points out that there is a huge oversupply of cannabis production in Canada at the present time. To make matters even worse, he refers to a recent must-read article from BNN Bloomberg that illegal sellers of cannabis in Canada have 89-90% of the total Canadian cannabis market share.
The reason is simple: black market cannabis is much cheaper than the highly regulated store-sold marijuana. Statistics Canada said the average cost of a gram of cannabis fell 6.4% in the third quarter as the legal price fell for the first time, but illicit weed continued to be cheaper. The average legal cannabis price dropped to $10.23 per gram while the average illegal price of pot continued to fall and slipped to $5.59 per gram.
So between the oversupply of the legal cannabis product and the cheaper black market product, companies like Aurora Cannabis have basically no chance of making a decent profit.
Aurora Cannabis Stock Will Likely Fall to Tangible Book Value
As it stands today, Aurora Cannabis has a market value of about $4.62 million CAD ($3.526) as of yesterday’s close.
But Aurora Cannabis has a very weak balance sheet. It had only $218.79 million CAD in cash as of June 30, 2019. But Aurora had $436 million CAD in current liabilities and $1.11 billion in long-term liabilities.
Moreover, its operating cash losses were $192 million CAD for the year ending June 30, 2019. And its free cash flow was negative $606.5 million CAD.
Finally, shareholders’ equity (i.e. book value) was $4.39 billion. Given that today’s price gives Aurora Cannabis stock a stated price-to-book value ratio of 1.11. But this is not the full story.
Deducting Aurora’s Goodwill and Other Intangibles
Aurora carries a huge amount of goodwill on the asset side of its balance sheet. This amounts to $3.17 billion CAD. Aurora has made a lot of acquisitions and overpaid for them. This overpayment accrues on the balance sheet as an intangible asset, i.e., an asset without any real tangible value, as goodwill.
In addition, Aurora has $688.3 million CAD in other intangible assets on its asset side of the balance sheet.
So at today’s price, the market is valuing all of these intangible assets at their full value. A more realistic price for Aurora Cannabis stock would be to deduct the intangible assets from its book value. Then ACB stock would trade at a price close to reality for its tangible assets.
Deducting those intangible assets gives Aurora a value of just $524.7 million CAD (i.e., $4.39 billion CAD – $3.17 billion CAD – $688.3 million CAD). Now comparing $525 million tangible value to Aurora Cannabis stock market value today of $4.62 billion CAD, the ratio is about 10.7%.
That means Aurora Cannabis stock’s real value is only 10.7% of today’s price of $3.69.
Bottom Line on Aurora Cannabis Stock
Do you really want to own a stock like Aurora Cannabis with no real upside and a huge potential downside? You would be much better off buying a stock that pays a dividend, makes money and has enough free cash flow to buy back shares. These are called total yield stocks. That is the exact opposite of Aurora Cannabis stock.
As of this writing, Mark Hake, CFA, does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks and was launched on August 30. Subscribers receive a two-week free trial period.