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Why Did Quant Investor Cliff Asness Exit Aurora Cannabis (ACB) and HEXO Stocks?

Cliff Asness made his name as a PhD in finance, a market theorist, and financial trader before founding AQR Capital Management in 1998. The firm, one of many quant trading hedge funds that grew up in the late 80s and 90s, was successful, weathered the financial crisis of 2008, and today manages assets worth over $225 billion. Asness remains the firm’s Managing Principal.

In short, Cliff Asness knows the ins and outs of financial trading. So, when his firm exits a position – completely – it’s worth examining why.

This is what happened with AQR’s most 13F, filed with the SEC. The disclosure shows that AQR shed its entire holding in two Canadian cannabis producers, Aurora (ACB) and HEXO (HEXO). Both names are commonly bandied about as major players in Canada’s newly legal cannabis industry, and Aurora is, by production output, Canada’s largest cannabis company. And the AQR positions were substantial; to get out, the company had to dump 7,102,892 shares of ACB worth a total of $64,268,000, and 472,777 shares of HEXO valued at $3,124,000.

So, let’s look under the hood, and see just what’s going wrong that Asness jumped ship.

Aurora Cannabis (ACB)

Aurora presents us with the less clear case. To start with, the company isn’t just Canada’s largest marijuana producer, its output is accelerating. The company beat the production expectations in its last quarter, with nearly 30,000 kilograms of cannabis and derivative products available for sale.

So, Aurora has a solid foundation, with plenty of product for sale. Good. What’s not so good is that the company is in the red, and even lowered forward earnings expectations for Q4, from C$111 million to the C$100 to C$107 million range. It was a bitter pill for investors.

Adding to the problems, Aurora may simply be overvalued. It has a market cap of US$5.9 billion, but Q3 revenues were just C$65 million and EPS was negative. That is not sustainable for any company.

And finally, while high production may be a long-term positive, in the short-term Aurora has to deal with a supply crunch in its domestic market as Health Canada tries to work through a backlog of seller licenses. In that environment, adding more product to the supply chain will simply confuse the market’s pricing signals.

Piper Jaffray analyst Michael Lavery sums up the bears’ case on ACB: “Aurora has industry leading production capacity, which can drive near-term revenues, but there is still little visibility around some key industry growth opportunities. Aurora plans to export medical cannabis to European markets, but it cannot do so until it receives EU-GMP certification, which could take time. Its strategy for expansion into both the US CBD and THC markets is still unclear, and the Canadian market faces risk of oversupply, which we estimate is likely in calendar 2020.”

In line with those comments, Lavery puts a Hold rating on ACB, although his $7 price target does suggest an upside of 19% from current levels. (To watch Lavery’s track record, click here)

It appears the voice of the Street backs Lavery’s sidelined vantage point on the cannabis maker. Out of 7 analysts polled by TipRanks in the last 3 months, 4 remain sidelined, while 3 are bullish on Aurora stock. (See ACB’s price targets and analyst ratings on TipRanks)

HEXO Corporation (HEXO)

HEXO presents us with a much more straightforward bear case. The stock simply has nothing spectacular about it; it is just another Canadian marijuana company, trying to make a living in a recently legalized, suddenly crowded industry.

Like its peers, HEXO has its fingers all segments of Canada’s new cannabis sector: growing/production, sales, and export, for both medical and recreational uses. HEXO management is upbeat about next year’s expected legalization of edibles in Canada, and toward that end is partnering with Molson Coors (TAP) on development of cannabis-infused beverages. It’s a reasonable plan for future expansion, but other, larger cannabis companies are following similar paths. Canopy Growth (CGC) already has Constellation Brands (STZ) as a major stakeholder, and Cronos Group (CRON) has the same relationship with cigarette maker Altria (MO).

So where can HEXO differentiate itself? Its EPS has been consistently negative, and the upcoming September report is forecast to show more red ink. The share price peaked in April, has fallen by almost half since, and cannot seem to gain traction above $4. While there is great potential for high profits in the Canadian legal cannabis industry (and longer-term, globally), there is just no indication that HEXO is going to be a big player when the industry matures.

These are the factors that Jefferies analyst Ryan Tomkins was getting at, when wrote of his bottom line for HEXO: “Hexo’s Q3 results were below expectations on sales, gross margin… QoQ performance was also underwhelming, though this had been partly flagged by management at Q2. Expectations were at an all-time high given previously announced FY20 guidance, and mgmt presenting a number of risks and a cautious tone on the conference call was [not] taken well.”

All in all, Tomkins just doesn’t see HEXO as a stock to buy as he rates it ‘underperform.’ (To watch Tomkins’ track record, click here)


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