Company Reports

Shares of Canadian-licensed producers and US multistate operators rallied massively on news that the US Drug Enforcement Administration will proceed with rescheduling cannabis to Schedule III from Schedule I. Schedule I indicates it is considered to have a high potential for abuse and no medical value. In comparison, Schedule III drugs are considered less dangerous, with a lower potential for abuse and having some medical value. We view the April 30 news as the next step in a long process by the Biden administration to relax the current federal prohibition. We view the market reaction as a reflection of how much pressure these stocks have faced rather than any new development.

The Bundestag, the lower house of Germany’s legislature, passed a cannabis bill last month that would allow possession of up to 25 grams and home-growing of up to three plants. The law will become effective April 1 as planned after the Bundesrat, the upper house, voted not to send it to mediation committee on March 22. The law expands on July 1 to allow nonprofit cannabis grow clubs of up to 500 members and 50 grams per member.

On Feb. 20, no-moat Aurora completed a previously announced 1-for-10 reverse split of its shares to keep its Nasdaq listing. This move has no effect on Aurora's intrinsic value, but this isn't the first time it was forced to consolidate shares, underlining the significant dilution risk. Separately, the company announced that Simona King would replace Glen Ibbott as chief financial officer, effective Feb. 21. The change seems sudden, although King's decades of experience in corporate finance seem adequate for the position. Still, it doesn't alter our Poor Capital Allocation Rating for Aurora.

Aurora Cannabis cultivates and sells cannabis predominantly in Canada but also exports to the global medical market. It considers itself a medical cannabis company first, as adult use accounts for roughly 25% of net revenue, less than peers. We expect medical cannabis revenue to grow in the high single digits over the next 10 years, with robust international growth offsetting declining Canadian sales. We forecast strong adult-use growth in the low double digits, driven by the conversion of illicit-market consumers into the legal market and new cannabis consumers. Still, we expect medical to constitute most of sales by 2033.

Aurora Cannabis reported decent fiscal third-quarter results, as net revenue grew 2% sequentially and 5% over the prior year to CAD 64 million. Profitability improved, too, with adjusted EBITDA margin expanding to nearly 7%, up 140 basis points sequentially. On earnings alone, we wouldn’t expect to change our fair value estimates of $1.80 and CAD 2.40 per share for no-moat Aurora. In addition, our initial reaction to the acquisition of MedReleaf Australia is that any benefit to intrinsic value is offset by Aurora’s use of shares to fund most of the deal. And although shares look undervalued, we’d reiterate our Extreme Uncertainty Rating as equity dilution remains a risk.

Aurora Cannabis cultivates and sells cannabis predominantly in Canada but also exports to the global medical market. It considers itself a medical cannabis company first, as adult use accounts for roughly 25% of net revenue, less than peers. We expect medical cannabis revenue to grow in the high single digits over the next 10 years, with robust international growth offsetting declining Canadian sales. We forecast strong adult-use growth in the low double digits, driven by the conversion of illicit-market consumers into the legal market and new cannabis consumers. Still, we expect medical to constitute most of sales by 2033.

We’re likely to lower no-moat Aurora’s per-share fair value estimates of $2/CAD 2.60 by high-single-digit to low-double-digit percentages as its share count grew by a higher-than-expected 9% in its second fiscal quarter. As we’ve stated before, the continued issuance of equity below intrinsic value destroys value for existing shareholders. We reemphasize our Extreme Uncertainty Rating amid the continued threat of material value destruction. So, while shares trade well below our fair value estimates, investors should understand the material risk in the stock. We think Aurora should be able to survive the much-needed rationalization in the Canadian market, but there’s a lot of factors that could affect our prediction.

On Aug. 30, shares of the U.S. cannabis multistate operators rallied around 20%, with Canadian licensed producers up less, following news that the U.S. Department of Health and Human Services recommended to the Drug Enforcement Administration that it reclassify cannabis to a Schedule III drug from Schedule I. Cannabis, along with heroin and ecstasy, is currently listed as Schedule I, which means it is considered to have a high potential for abuse and no medical value. Schedule III drugs are considered less dangerous, with a lower potential for abuse and having some medical value. Lower scheduling would not necessarily be a panacea for the cannabis industry, but it could be enough to bring some important benefits to U.S. multistate operators, including paying normal tax rates, improved banking access, and potential listing on a major U.S. stock exchange.

Aurora Cannabis cultivates and sells cannabis predominantly in Canada but also exports to the global medical market. It considers itself a medical cannabis company first, as adult use accounts for roughly 25% of net revenue, less than peers. We expect medical cannabis revenue to grow in the high single digits over the next 10 years, with robust international growth offsetting declining Canadian sales. We forecast strong adult-use growth in the low double digits, driven by the conversion of illicit-market consumers into the legal market and new cannabis consumers. Still, we expect medical to constitute most of sales by 2033.

No-moat Aurora’s fiscal first-quarter results were largely in line with our expectations, highlighted by decent revenue growth and continuation of positive albeit small, adjusted EBITDA. Although dilution of existing shareholders continued, it was largely within our forecast, so we don’t expect a major change to our fair value estimates of $2.30 and CAD 3.00 per share outside of the effect of currency exchange rates. Shares trade well below our fair value estimates, but we re-emphasize our Extreme Uncertainty Rating amid the threat of material value destruction. We see better risk-adjusted upside in U.S. multistate operator stocks, both from exposure to more favorable legal American markets as well as a lower risk of value destruction.

Aurora Cannabis cultivates and sells cannabis predominantly in Canada but also exports to the global medical market. It considers itself a medical cannabis company first, as adult use accounts for roughly 25% of net revenue, less than peers. We expect medical cannabis revenue to grow in the high single digits over the next 10 years, with robust international growth offsetting declining Canadian sales. We forecast strong adult-use growth in the midteens, driven by the conversion of illicit-market consumers into the legal market and new cannabis consumers. Still, we expect medical to constitute most of sales by 2033.

Not much of our long-term outlook for Aurora Cannabis is likely to change based on our initial reaction to fiscal third-quarter results, the end to a shortened fiscal 2023 as the no-moat company shifts its year-end date. We will update our model after more-complete financials are released, but we expect to reduce our $3/CAD 4 fair value estimate by a high-single-digit to low-double-digit percentage, in line with the shares' 8% drop in reaction to the results. Our cut is mostly due to further dilution of shareholders, with around 13 million shares being issued during and subsequent to the quarter well below our fair value estimate.

We were skeptical of Aurora’s prior assertions that it would deliver positive adjusted EBITDA in second-quarter fiscal 2023, but we were proven wrong. Indeed, no-moat Aurora reported second-quarter adjusted EBITDA of CAD 1.4 million. Although management warned that it hadn’t reached steady state profitability yet, we still view it as a solid milestone that the business is nearing requisite scale over fixed costs. Additionally, the company reported solid sequential cannabis revenue growth of about 20%. We think the results are particularly strong given that many Canadian peers struggled in their most recent quarters amid a market awash with competitors and handicapped by the low prices of the illicit market.

Aurora cultivates and sells cannabis predominantly in Canada but also exports it to the global medical market.

Aurora’s revenue declined. Average price per gram rose to CAD 5.32 and gross margin expanded to 50%, up from CAD 5.10 and from 47%, respectively. Additionally, continued cost-cutting efforts kept overhead expenses in check, allowing adjusted EBITDA losses to narrow to CAD 8.7 million, compared with CAD 11.5 million in the fiscal fourth quarter. We’ve maintained our forecasts and our fair value estimates of $4 and CAD 5 per share for no-moat Aurora. Shares trade in 4-star territory, but we reiterate our Extreme Uncertainty Rating on Aurora given the ongoing threat of dilution to existing shareholders.

President Joe Biden’s comments on cannabis legalization spurred a rally in the cannabis sector on Oct. 6. His major announcement was that all prior federal offenses of simple marijuana possession will be pardoned. The act is expected to affect approximately 6,500 people convicted from 1992 to 2021. Additionally, Biden called upon governors to take similar action toward pardoning possession offenses. More importantly for the legal cannabis industry, he plans to direct the Department of Health and Human Services and attorney general to review the product’s status as a Schedule 1 controlled substance, which places it among heroin and LSD and higher than methamphetamine and fentanyl.

Aurora's cost-cutting efforts bore fruit in FY 2022 as adjusted EBITDA losses fell by more than half to CAD 51 million from CAD 114 million in FY 2021. This progress is particularly impressive given that net revenue actually declined by 10% year over year to CAD 221 million. Management has targeted positive adjusted EBITDA by its second fiscal quarter ending Dec. 31, 2022, but we'd be surprised by such rapid improvement. Fourth-quarter adjusted EBITDA losses alone were nearly CAD 13 million, so some combination of better revenue growth, higher gross margin, or larger cuts to overhead expenses than we expect would need to happen. We think the company will reach positive adjusted EBITDA roughly a year later, sometime in fiscal year 2024.

Aurora cultivates and sells cannabis predominantly in Canada but also exports it to the global medical market.

On May 26, Aurora announced a $125 million equity raise, which has now been upsized to $150 million, that’s left us scratching our heads. The expanded deal consists of 61.2 million units at $2.45 per unit, which consists of one share and one warrant to acquire an additional share at a price of $3.20 over the next three years. Given the massive discount to our unaffected fair value estimates, we see the deal as very dilutive to existing shareholders. As such, we’ve cut our fair value estimates to $4 and CAD 5 from $7 and CAD 9, respectively, in line with the market drop of nearly 40% as we write.

Aurora cultivates and sells cannabis predominantly in Canada but also exports it to the global medical market.