ACB Stock Bearish Due to High Balance Sheet Stress

Stocks to sell

2019 was a year cannabis investors would like to forget, including Aurora Cannabis (NYSE:ACB) shareholders. But it still might be optimistic to assume cannabis stocks have bottomed out. The same holds true for ACB stock, and I maintain a bearish view for 2020. I believe that balance sheet concerns coupled with industry headwinds will ensure bearish sentiments sustain due to key challenges coming up in the near to medium term.

ACB Stock Bearish Due to High Balance Sheet Stress

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Unfortunately for ACB stock, there is no dearth of reasons to be bearish.

Piper Sandler analyst Michael Lavery opined that the stock is headed for a target of $1. Christopher Carey, analyst at Bank of America Merrill Lynch, assigned a “sell” rating to ACB stock. Both analysts cited balance sheet problems as one of the company’s key challenges. Additionally, in December 2019 Owen Bennett, analyst at Jefferies, downgraded Aurora Cannabis from “buy” to “hold.” The point I’m making is that the markets have a very bearish view of the stock, and there are strong reasons to remain pessimistic.

Balance Sheet Stress and Dilution Risk

One of the primary reasons for downgrading ACB stock has been the pressure on the balance sheet. For the first quarter of fiscal year 2020, Aurora Cannabis reported cash and equivalents of 153 million CAD. For the same quarter, the cash used in operations was 95 million CAD.

If cash burn sustains at the same rate, Aurora Cannabis will need additional equity or debt funding in the second half of 2020. That seems very likely and the stock is discounting dilution or leveraging concerns, among others. There are two major potential negative triggers.

First, the year 2020 is likely to see high marketing and selling expenses. The company is rolling out “cannabis 2.0” products including gummies, chocolates, baked goods and mints. With higher marketing expenses, ACB will burn cash faster and dilution is likely sooner.

Second, if these “cannabis 2.0” products fail to gain traction, ACB stock will trend lower. The company is relying on recreational cannabis to trigger growth in the medium-term. Medicinal cannabis is unlikely to be a growth trigger since clinical research and regulatory approval will take time.

The Long Path to Medicinal Cannabis Growth

Aurora Cannabis is looking at medicinal cannabis as one of its major growth triggers. However it seems overly optimistic to expect growth from this segment in the next 12 to 24 months.

According to the U.S. Food & Drug Administration, the only approved CBD drug is Epidiolex. The FDA has specifically warned that “selling unapproved products with unsubstantiated therapeutic claims is not only a violation of the law, but also can put patients at risk.”

There is no shortcut to inroads for the medicinal cannabis segment. Progress will be slow and the markets have been discounting this factor. Aurora Cannabis is working on clinical research related to pain, epilepsy, PTSD, anxiety, opioid sparing, cancer and neurodegeneration. If results are positive in the coming years, medicinal cannabis will gain traction. But investment in clinical trials and research and development will involve sustained cash burn.

Setback in Europe

Besides growth in Canada, Aurora Cannabis is focused on Europe for growth. However, the company had few setbacks in the recent past and that adds to the negative triggers.

In November 2019, Aurora Cannabis products were suspended from Germany until further notice. The German authorities are investigating the methods used by Aurora Cannabis to increase the shelf life of cannabis. The important point to note is that German cannabis market is expected to be worth $9.4 billion by 2028. Therefore, this is a big setback in a high potential market.

Further, in November 2019, Italy cancelled one of the three lots of cannabis supplied by Aurora. The given reason was noncompliance with European Union Good Manufacturing Practice standards.

These incidents could impact growth and regulatory hurdles are a major headwind.

The Bottom Line On ACB Stock

ACB stock has been battered in 2019 and I don’t see any respite in 2020. Cash burn remains a big challenge, and additionally, I believe that slow growth in medicinal cannabis segment will affect stock sentiment.

The industry is still at a stage where R&D and marketing expenses are set to remain high in coming years. Therefore, equity dilution or leveraging is likely in 2020 and can further depress ACB stock.

Overall, it makes sense to stay away from Aurora Cannabis even after the big decline of 2019.

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

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