Times have been tough for cannabis operators. This is especially true for the Canadian firms in the space since many of them have taken on significant leverage and/or big investments to boost their production capacity only to be crippled by tumbling prices and the industry oversupply that caused them. Few firms have been as affected as Aurora Cannabis (ACB), one of the largest players in the market. Despite the pain seen by Aurora, management continues to focus on cost-cutting. While the end result will have been a major step back for the firm, these moves are a necessary evil for the company to become right-sized again and to eventually move toward profitability. A great deal still needs to be done to get there, but any sort of progress should be applauded.
Signs of improvement
Earlier this month, the management team at Aurora announced some preliminary expectations for the fourth quarter of its 2020 fiscal year. For instance, they said that investors should expect net revenue to range between $70 million and $72 million for the quarter, with cannabis net revenue to be between $66 million and $68 million. This compared to $75.5 million seen for net revenue a quarter earlier and it’s down from $69.6 million seen for cannabis net revenue in that same quarter.
Overall, a decline in sales is a net negative for any firm, but with weak pricing and management unwinding non-core operations from the firm, it’s to be expected. Fortunately for investors, it seems that sales came in toward the high end of what was expected. Total net revenue actually exceeded the upper limit, hitting $72.1 million, while net cannabis revenue totaled $67.5 million. To understand precisely what is happening with Aurora, we should dig a bit deeper though.
At the end of the day, there really are two key components for determining Aurora’s sales: volume of cannabis equivalent sold and the price at which it’s sold. In the latest quarter, volume came in strong, relatively speaking. The figure totaled 16,748 kg (kilograms). This was up 31.6% compared to the 12,729 kg sold one quarter earlier. This is all net of product returns. I view this outperformance as a really positive sign because while it’s clear there’s an issue with industry oversupply, at least the firm is not being hit again by weakening demand for its products.
This is not to say there is a volume issue though. I do believe that Aurora is producing far too much cannabis and that could be a source of its profit issues. During the latest quarter, the company produced 44,406 kg of the product, up from 36,207 kg a quarter earlier. The firm does continue to invest in R&D to bring new and improved products to market. Growth is also difficult to curtail. But at the end of the day management probably needs to see some of this output drop.
While volume looks good for the business, the same cannot be said of pricing. During the latest quarter, Aurora sold its average gram at $3.60. This is down considerably from the $4.64 per gram seen just one quarter earlier. Management chalked this up to the company’s value brand segment, Daily Special, accounting for 62% of flower revenue during the quarter. This is up from 35% one quarter earlier. To put that in perspective, customers decided to gravitate toward low-priced, low-margin, low-quality products as opposed to premium products. This suggests that there is, indeed, weakness in the pricing side of the market. It also suggests that, perhaps, Aurora has not cut costs enough on its higher-quality products to keep them competitive with the market.
As a result of all of these pressures, you would think that Aurora’s bottom line would have suffered. If we use EBITDA as the appropriate measure, however, the picture for the firm was actually upbeat. During the quarter, EBITDA was -$34.6 million. This is favorable compared to the -$50.4 million seen one quarter earlier. Despite the lower selling prices the firm benefited from some cost-cutting. According to management, selling, general, and administrative costs during the quarter came out to $60.1 million. This is lower than the $73.3 million seen in the third quarter this year. In addition, the cash cost per gram of product came in at just $0.89 compared to $1.22 three months earlier. While EBITDA was better, operating cash flow did worsen some, with the net outflow expanding from -$54.8 million to -$63.9 million. Fortunately, capex came in lower to the tune of $51.2 million, so free cash flow did improve.
Realistically, Aurora is still in a rather nasty position. Cash on hand is only $162.2 million now and that won’t be enough to last forever. Management does believe that EBITDA will turn positive by the second quarter of its 2021 fiscal year, but even that doesn’t mean that the firm will be cash-flow positive. To help alleviate concerns, the business did say that it has now reduced its quarterly selling, general, and administrative costs to the low $40 million range. By the second half of its 2021 fiscal year, this should fall another $10 million per quarter due to facility closings. Management also arranged to cancel its partnership with the UFC, paying up $30 million in cash (which will come out in the first quarter of 2021) in order to avoid over $150 million in fees, research costs, and marketing over a span of five years. The issuance of 36.6 million shares at the market also helped to buoy the firm, as will the sale of non-core subsidiaries that will leave all of the company’s net revenue coming from cannabis moving forward.
All of these changes should have a nice impact on Aurora. Revenue moving forward is expected to range between $60 million and $64 million, plus the prospect of positive EBITDA shows that the business is moving in the right direction. Having said that, until the firm can right-size itself appropriately and perhaps until there’s some recovery in the cannabis market, investors should expect more equity to be issued by the firm with the expressed aim of covering the cash shortfalls it will face.
Based on the data provided, it seems clear to me that Aurora is far from being out of the woods at this time. Having said that, the firm does seem to be making some excellent progress and so long as this continues the business has a chance to recover. The road there will be a long and arduous one, but it’s necessary to avoid a rather messy alternative.
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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.