| Aurora Cannabis Inc. (ACB, U.S. and Toronto) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | The Author(s) hold no shares |
| Based on financials from: | 2019 + Q1 ’20 |
| Last updated: | January 5, 2020 |
| Share Price At Date of Last Update: | $ 2.60 |
| Currency: | $ Canadian |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | Highly Speculative |
| Has Wonderful Economics? | Not yet clear |
| Has Excellent and Trustworthy Management? | Remains to be seen |
| Likely to grow earnings per share at an attractive rate over the next decade? | Yes |
| Positive near-term earnings outlook? | No |
| Valuation? | Inconclusive |
| SUMMARY AND RATING: This is our initial look at Aurora. It is a complex company in a new industry. There are many aspects of the company that we are not familiar with. Aurora Cannabis is still an early stage company that has not yet reached profitability. The Value ratios are inconclusive at this stage. Management quality remains to be seen (we are concerned about the debt that they took on which could be problematic or even fatal). The insider trading signal is mixed with the CEO buying but several others selling. Executive compensation is not a concern. The outlook is questionable as sales in Canada may be slow to grow during 2020 and the company will likely remain unprofitable during 2020. Running out of cash during 2020 appears to be a possibility. However, it has been selling shares in New York which helps to mitigate that risk. This could be a significant source of cash although as of now it would be at low share prices. The economics of the business are not yet clear. It appears to make high margins on its production but so far those margins do not exceed all its costs. Overall, it is clear that this is a highly speculative investment and we are not yet prepared to rate it either a sell or a buy. At most, we would risk only a (very) small speculative investment in this company at this time (if any). | |
| LONG TERM VALUE CREATION: This remains to be seen. | |
| DESCRIPTION OF BUSINESS: Aurora describes itself as a Canadian-owned licenced producer of both medical and recreational cannabis with operations and sales in more than 20 countries. The 2019 annual report indicates it has 15 global production facilities. | |
| ECONOMICS OF THE BUSINESS: This remains to be seen. | |
| RISKS: Aurora faces at least some risk of running into financial difficulty before it reaches profitability. Some analysts have reported that the Canadian production capacity in 2019 was six to eight times larger than sales. Unless sales increase dramatically, many producers will be forced out of business. See annual report for additional risks including the many risks associated with producing in a heavily regulated environment. | |
| INSIDER TRADING / INSIDER HOLDING: Checking insider trading from September 1, 2019 to January 3, 2020: A Director sold 10,000 shares on December 9th at $3.30 to hold 34,000. Director Terry Booth (who is also a co-founder and the CEO) purchased 270,000 shares in November at $3.68 and then an additional 73,500 shares on January 2, and 3rd at $2.68 and $2.72. He holds 11.4 million shares through Lola Ventures Inc. and so this is a strong show of confidence. Another director, however, sold 1.1 million shares on December 17th at $3.10 to hold 791,000. Another director sold 83,000 shares on December 12th and $3.30 to hold 21,000. This is a mixed picture. Insiders buying shares with their own money tends to be rare and so the one director purchasing is quite positive. Overall the signal here is neutral. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand and predict (pass or fail and why), has favorable long-term economics due to cost advantages or superior brand power (pass or fail and why), apparently able and trustworthy management (pass or fail and why), a sensible price – below its intrinsic value (pass or fail and why), Other criteria that have been attributed to Buffett include: a low debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass or fail) | |
| MOST RECENT EARNINGS AND SALES TREND: The company does not make a profit on an operating basis. During fiscal 2019 revenues grew substantially each quarter on a sequential basis as Cannabis became legal in Canada in its Q2. However, revenue was 14% lower in Q1 fiscal 2020 (ended September 30) versus Q4 fiscal 2019. This was blamed on excess inventory in the provincial distribution systems and the slow retail rollout. | |
| COMPARABLE STORE SALES OR INDUSTRY SPECIFIC STATISTICS | |
| Earnings Growth Scenario and Justifiable P/E: The company is not yet profitable. | |
| VALUE RATIOS: Analysed at $2.60. The price to book value is ostensibly attractive at 0.61. However, given that the assets consist mostly of goodwill purchased in an over-heated market, that figure is probably irrelevant. The price to tangible book value is not particularly attractive at 4.4. The company is not making money on an operating basis and so there is no P/E ratio or ROE. Overall, the value ratios do not provide any real signal. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | Aurora Cannabis Inc. |
| Currency: | $ Canadian |
| Contact: | 0 |
| Web-site: | 0 |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $75.2 |
| Latest four quarters annual earnings $ millions: | not available |
| P/E ratio based on latest four quarters earnings: | not available |
| Latest four quarters annual earnings, adjusted, $ millions: | $(119.3) |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: Adjusted for major non-operating items in other income. Most did not appear to require a tax adjustment. | |
| Quality of Earnings Measurement and Persistence: There are no operating earnings yet. | |
| P/E ratio based on latest four quarters earnings, adjusted | negative |
| Latest fiscal year annual earnings: | $(297.9) |
| P/E ratio based on latest fiscal year earnings: | negative |
| Fiscal earnings adjusted: | $(414.7) |
| P/E ratio for fiscal earnings adjusted: | negative |
| Latest four quarters profit as percent of sales | -158.6% |
| Dividend Yield: | 0.0% |
| Price / Sales Ratio | 8.98 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 0.61 |
| Balance Sheet: (As of September 30, 2019) The assets are comprised as follows: A hefty 57% of assets is purchased goodwill. A further 12% is other intangibles including licenses and the value of customer contracts purchased. 17% is property, plant and equipment (largely greenhouses including some still under construction) 4% is cash and cash and other current assets including inventory total 10%. 2% is an investment in Alcanna retail. The assets are supported 80% by common equity, 14% by debt and the remainder by accounts payable, a deferred tax liability and other. It’s not clear if this is a strong balance sheet since the value of the goodwill may be far less than they paid for it. The debt level is a concern given that they are not yet profitable on an operating basis. | |
| Quality of Net Assets (Book Equity Value) Measurement: Low quality given the huge amount of goodwill and other intangibles in combination with the lack of operating profits. | |
| Number of Diluted common shares in millions: | 1,039.7 |
| Controlling Shareholder: We did not see any information on this. It appears that there is no controlling shareholder. | |
| Market Equity Capitalization (Value) $ millions: | $2,703.2 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 79.7% |
| Interest-bearing debt as a percentage of common equity | 18% |
| Current assets / current liabilities: | 1.3 |
| Liquidity and capital structure: Aurora’s balance sheet appears weak in that the majority of its assets consist of goodwill , it has significant debt and it is not yet a profitable company. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | -2.7% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | -14.0% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | -4.4% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| X years compounded growth in sales/share | not available |
| Volatility of sales growth per share: | $ – |
| X Years compounded growth in earnings/share | not available |
| X years compounded growth in adjusted earnings per share | not available |
| Volatility of earnings growth: | $ – |
| Projected current year earnings $millions: | not available |
| Management projected price to earnings ratio: | not available |
| Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? | Too new to say |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | -14.0% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | not available |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | No prediction |
| OUTLOOK FOR BUSINESS: The sequential decline in revenue in Q1 2020 due to excess inventory in the provincial distribution system could continue to impact sales in the coming quarters. Offsetting this, industry sales will be growing as more retail stores open and as edible products become legal. Aurora should also benefit from increased international sales. Overall, it appears that Aurora will continue to generate losses during 2020. | |
| LONG TERM PREDICTABILITY: | |
| Estimated present value per share: This calculation is not applicable since the company is not yet profitable. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (Marginal pass, as producers require a license, but there may be many licenses granted). No issues with powerful suppliers (pass). No issues with dependence on powerful customers (fail, as the provincial governments are both customer and regulator), No potential for substitute products (pass) No tendency to compete ruinously on price (marginal pass, this basically remains to be seen). Overall this industry appears to be of questionable attractiveness even to large incumbents. | |
| COMPETITIVE ADVANTAGE: Aurora may have advantages in terms of scale. But as an indoor grower it may not be competitive with outdoor growers including from other countries. | |
| COMPETITIVE POSITION: | |
| RECENT EVENTS: In November it converted $230 million of soon-to-mature convertible debentures into shares at $3.28 (a 6% discount) with the agreement of over 99% of the holders. Apparently these were held privately. We would be concerned that the reason for doing this was lack of cash to pay out the debentures. They have been issuing shares to raise money through share sales at the market price in New York. (The opposite of share buybacks and something not common and we believe not allowed on the Toronto stock Exchange.) During the 3 months ended September 30, $57 million was raised by selling shares at a average of $7.60 Canadian currency. They have suspended construction on two large Greenhouses, a very large facility in Medicine Hat that is apparently near completion and a much smaller facility in Denmark. The suspensions are to conserve cash and are therefore a sign of possible financial difficulty. The 2019 annual report indicates that the company has made over 17 strategic acquisitions. The great majority of these were purchased with shares and not cash. | |
| ACCOUNTING AND DISCLOSURE ISSUES: There are many complexities in the accounting. This includes various mark to market gains and losses, the valuation of inventory and large stock option expenses. | |
| COMMON SHARE STRUCTURE USED: | |
| MANAGEMENT QUALITY: We are concerned that management may have spent too much money too fast on both production facilities and acquisitions. Also, they may have made a poor choice in getting into debt as opposed to using only equity financing until such time as they are profitable. | |
| Capital Allocation Skills: Probably poor in that they likely greatly over-paid for many of their acquisitions. However, the fact that the acquisitions were paid for almost entirely with shares as opposed to cash mitigates the damage. It may also have been a poor (and potentially fatal) decision to finance some of their assets with debt rather than funding strictly with equity until such time as profitability could be demonstrated. | |
| EXECUTIVE COMPENSATION: Based on fiscal 2019 that ended June 30, 2019. Compensation for the five names officers ranges from $1.3 million to $2.4 million. The majority of that consisted of options and share-based compensation some of which may never be realised due to the recent share price decline. Overall, compensation is not a concern. | |
| BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. Here there are eight ,members. Two are co-founders who had put significant amounts of their own money into the company, which is positive. The remaining members appear to be well qualified. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
| © Copyright: InvestorsFriend Inc. 1999 – 2019. All rights to format and content are reserved. | |