Aurora Cannabis: This Can’t Continue – Aurora Cannabis Inc. (NYSE:ACB)

Welcome to our Cannabis Earnings series where we break down the latest earnings to help you focus on the most important topics.

Introduction

Aurora Cannabis (ACB) reported its fiscal 2020 Q2 results last week. Although the company pre-released its revenue range when it also announced sweeping changes to its management and strategy a few days before, there are still many important observations to be made about this quarter.

(All amounts in C$)

Train Wreck

Aurora reported fiscal 2020 Q2 results for the three ended on December 31, 2019. The company reported total net revenue of $56 million which is 26% lower than the previous quarter. The decline was driven by softness across all revenue segments, particularly the Canadian recreational and wholesale channels. Recreational sales in Canada fell 24% and wholesale revenue collapsed 77% last quarter, signaling that Aurora is struggling to offload its products under a currently oversupplied cannabis market. The medical cannabis market continues to shrink in Canada and we expect a slow decline in this segment going forward given the current state of the market.

(Source: Public Filings)

Aurora sold 9,501 kg of cannabis in Q2 which is 24% lower than the previous quarter. In response to the soft demand, Aurora cut production by 26% to 30,691 kg last quarter. However, the company still produced too much cannabis and it continues to burn cash through working capital buildup. The company already scrapped plans for two large greenhouses in Canada and Denmark but its existing footprint still has a nameplate capacity of 150,000 kg per year or 37,500 kg per quarter. Until demand improves drastically in Canada, we expect Aurora to continue curtailing production in a bid to reduce inventory and minimize cash outflows. The company now has a smaller production footprint than Canopy (CGC) and Aphria (APHA).

(Source: Public Filings)

During Q3, Aurora saw its wholesale prices collapse 45% to only $1.90 per gram, which is much lower than investors’ previous expectations. As we noted in our November 2019 analysis “HEXO: Emerging Signs Of Price Compression In Canada“, LPs began reporting lower average selling prices as early as mid-2019. We have been warning investors about the upcoming oversupply including our 2019 cannabis sector outlook published in early 2019. The combination of a 45% decrease in wholesale prices and a 26% production reduction puts immense pressure on Aurora’s revenue growth outlook. While medical prices remain stable, recreational prices saw meaningful compression last quarter which did not have the contribution from 2.0 products. I think the general expectation from investors is that average prices will improve with the introduction of higher-margin 2.0 products.

(Source: Public Filings)

Living On Borrowed Times

It is no secret that Aurora is facing a severe liquidity crisis. However, the results from the second quarter last week showed that the company is only staying afloat because of its ATM equity program, which allows it to constantly dilute existing shareholders by issuing new shares in the market. This is essentially the reverse of a share buyback program that is used by normal companies with excess free cash flow. In the last quarter, Aurora lost $134 million from operations while spending another $128 million on capital expenditures. In order to fund those activities, the company issued 70 million shares at $3.83 per share to earn net proceeds of $262 million. It is safe to say that the Aurora would be in much deeper trouble had it not been able to issue all the shares through its ATM program.

(Source: Public Filings)

Aurora reported $156 million of cash and $45 million of restricted cash at the end of Q3, which is relatively unchanged from Q2 thanks to its massive ATM program. However, the original ATM equity program was only US$400 million which means that Aurora will likely increase the limit to continue raising much-needed cash. Aurora also announced that it eliminated the EBITDA covenant from its credit facility, as no one is expecting the company to reach that milestone in the near future. Post Q2, Aurora used $45 million of its restricted cash to repay a portion of the term loan which has a remaining balance of $162 million. The company has access to a $50 million revolver of which $2 million was drawn. It also has US$345 million of convertible debentures due in February 2024 on which it is paying an excellent 5.5% per annum. We think Aurora could use the same tactic to force convert these debentures at market prices if it doesn’t have the cash to repay them in 2024. Given the Q2 cash burn, we think Aurora could literally face a liquidity crunch in the next 2-3 quarters if it doesn’t reduce spending or raise new capital.

Looking Ahead

Based on the current trajectory, Aurora is almost destined to run out of cash in the next 2-3 quarters. In the Q2 release, Aurora announced plans to reduce SG&A to a run-rate of $40-$45 million by fiscal 2020 Q4 (Aurora spent $100 million on SG&A in Q2). Aurora is also laying off employees, cutting back on capital expenditures and all non-essential costs. We don’t think these cost-saving initiatives will be enough given that Aurora lost $134 million from operations in Q2 alone. To avoid an imminent failure, we expect Aurora to continue issuing as many shares as possible under its ATM equity program. It is also possible that Aurora is negotiating a capital infusion from outside sources such as a strategic partner or a private investor. We think new capital infusion is almost required to avert a near-term liquidity crunch.

(Source: TSX)

Because of the extremely delicate financial situation, we think investors should avoid Aurora until there is better clarity on its go-forward funding strategy. The company has been able to avoid going belly up only by issuing $320 million of equity in the open market, borrowings, and selling off its investments in other companies. Aurora realized its mistake way too late and it only took drastic actions to stay alive last week when it should have done so six months ago. At this point, Aurora almost certainly needs a bailout from someone else but it is unclear who could be its savior.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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