On Feb. 13, I warned investors holding Aurora Cannabis (NYSE: ACB) stock there could be more pain ahead. Since then, the stock is down another 49.6% to trade under 75 cents.
This week, Aurora announced a new $350 million equity facility and a 12-to-1 reverse stock split. Aurora stock has tremendous upside if the company can demonstrate significant earnings upside in the next two quarters and improvement on cash burn. If not, ACB is likely headed to $0.
With Aurora’s next earnings report roughly a month away, only extremely risk-tolerant traders should be buying the stock at this point. Aurora is essentially a lottery ticket: likely a loser with a small chance of paying off big.
Reverse Stock Split
This week, Aurora announced the latest in a series of increasingly desperate measures to keep afloat. On Monday, Aurora said it will be conducting a 12-to-1 reverse stock split. The split is intended to help Aurora maintain its NYSE listing, as all NYSE stocks need a share price above $1.
The dreaded reverse stock split is like a scarlet letter for a stock. In theory, neither stock splits nor reverse stock splits create or destroy value for investors. They simply change the percentage of ownership represented by each share of stock.
The old cliche of the pizza is the easiest explanation. The pizza can be cut into 24 tiny slices or two halves: it’s still the same pizza.
It’s the connotation of the reverse stock split that makes them bad news for investors. Stock splits are generally positively received by the market. Reverse spits are negatively received.
Forward stock splits are a signal that a stock price has risen too high. Obviously, that is good news and a badge of honor for a company. If a company is forced to conduct a reverse stock split, it typically means the stock has performed so poorly that it cannot maintain exchange compliance.
Aurora stock is a textbook case of the latter. The stock is down 91% in the past year. In general, those types of stocks tend to continue to perform poorly over time.
In fact, a study by Ibbotson & Associates found that stocks that underwent reverse stock splits from 1926 to 2017 underperformed the market by an average of 4.3% annually over the following five years.
The Numbers
In addition to the reverse stock split, Aurora made several other announcements. It announced a new at-the-market equity offering under which it is authorized to raise up to $350 million in capital.
One of the biggest Aurora stock bulls on Wall Street is Cantor Fitzgerald analyst Pablo Zuanic. Zuanic says Aurora will only actually need a fraction of this capital.
“We assume the company will only need to use about a quarter of the facility over the Jun and Sep qtrs. (for 5-6% dilution, depending on average prices), as lower capex and cost cuts transition ACB to a [free cash flow] positive state sometime in FY21,” Zuanic says.
However, Zuanic estimates a fully utilized equity offering could further dilute current shareholders by about 30%.
Aurora had $205 million in cash as of the end of March. Zuanic estimates Aurora burned $174 million in cash in the fiscal third quarter.
“We realize the company announced cost cutting and lower capex in mid-February, but we would have expected to see greater improvement in cash burn in the Mar qtr,” Zuanic says.
Cash burn is king right now in cannabis. It’s the one thing that needs to improve for Aurora stock to pull out of its nosedive.
Zuanic has an “overweight” rating and $1.98 price target for Aurora stock.
How To Play Aurora Stock
Investors need to be careful with Aurora stock. It has tremendous upside given its positioning in the Canadian cannabis market. But its stock will only realize that upside if the company can get its act together from the financial side. At this point, the company has given investors almost no reason to believe it will.
I’ve said repeatedly that the cannabis space will ultimately produce some huge winners and huge losers. Every passing day, Aurora stock is looking more and more like it will be a loser.
My favorite cannabis stock right now is Canopy Growth Corp (NYSE: CGC). I like (and own) Canopy stock because it has a relatively healthy balance sheet and a deep-pocketed financial backer in Constellation Brands (NYSE: STZ).
If Aurora management can break the cycle of cash burn and equity dilution, the stock has tremendous long-term upside. However, at this point the stock is little more than a gamble.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, Wayne Duggan was long CGC stock.