Bank of America said “no” to marijuana company Aurora Cannabis (ACB).
In a downgrade announced late last week, BofA analyst Christopher Carey cut his rating on Canada’s second largest cannabis grower by market cap, removing his “buy” rating and reducing the stock to “neutral.” Aurora’s price target likewise fell, from $10 a share (US) to $8. (To watch Carey’s track record, click here)
Why is BofA putting down the pipe? Two words: Cash … and debt.
With $400 million worth of cash and equivalents in the bank, and only $313 million in long-term debt, you might not think Aurora Cannabis was a company particularly worried about cash. However, as Carey explained, Aurora also needs to spend a lot of cash to fuel its growth plans.
With an annual production capacity of 65,000 kilograms of cannabis at the end of last quarter, Aurora is targeting an increase to 150,000 kg of cannabis early next year, en route to a goal of more than 600,000 kg of capacity by the end of 2020. Such expansion plans, however, “require significant levels of capital,” notes Carey.
“Aurora has 4 production facilities in various stages of construction or expansion, with ~1.35mn new sq feet of facility space [expected] in Canada, Denmark and Portugal.” By Carey’s estimation, this new production space will require spending of about C$270 million in total ($206 million US).Simply maintaining all the infrastructure it is building could cost Aurora Cannabis C$100 million ($76 million US) a year.
Summing up, Carey predicts that over the next four fiscal quarters, Aurora will need to spend C$365 million on capital investment. Combined with negative cash from operations, the analyst anticipates that total free cash flow for the period will approximate negative C$420 million (negative $321 million US).
Admittedly, this situation is not exactly unique among cannabis companies. Last year, Aurora Cannabis burned through more than $270 million in negative free cash flow — but Cronos Group burned more than $90 million, and Canopy Growth burned nearly $200 million, too. But it’s not Aurora’s condition relative to other cannabis companies that concerns Carey, but rather its situation relative to the immediate future.
What specifically worries Carey about that future is a “large convertible debenture, equating to C$230mn” in value that is coming due for Aurora in Q1 2020. If Aurora’s share price remains depressed, and holders of said debenture demand repayment in debt rather than converting to equity, Carey fears the addition of C$230 million in cash outflow from the debt repayment, combined with C$420 million in negative free cash flow, will erase Aurora’s current cash-positive position and leave the company with nothing but debt on its balance sheet — potentially necessitating taking on even more loans to build up cash to pay for continued expansion.
Granted, these loans are Aurora Cannabis’s for the asking. The company has a “shelf prospectus” on file with the SEC already, entitling it to raise up to $750 million through the sale of shares or issuance of debt (along with C$50 million more available from an existing credit facility). But Carey would rather see the company use this capability to raise funds for further expansion, partnership, or acquisition — not simply to shore up its balance sheet.
The fact that it fears Aurora will have to raise cash to play defense, therefore, is a negative in the analyst’s view — and the primary reason Aurora stock is no longer a “buy.” (See ACB’s price targets and analyst ratings on TipRanks)