Canadian pot stocks had a disappointing 2021, but this year doesn’t look rosy either. Recently, popular cannabis players Canopy Growth ( CGC -4.08% ) and Aurora Cannabis ( ACB -4.07% ) reported dismal quarterly results. Aurora Cannabis, in particular, has been unprofitable for quite a while now with declining revenue and ineffective cost management strategies.
Soon after the results, Aurora announced that it is acquiring Ontario-based Thrive Cannabis. An acquisition at this point doesn’t seem to be a wise idea. Let’s take a look at this in more detail and determine whether this acquisition will be good for Aurora or if it is just digging its grave deeper.
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Self-inflicted wounds
When demand soared in Canada after marijuana legalization, Aurora Cannabis went on an acquisition spree and burdened its balance sheet. When it failed to grow revenue to match its production, it had to shut down most of its larger production facilities through what it called a “cost rationalization” process. It has helped Aurora to some extent in saving money. As per its recent fiscal 2022 second-quarter results, for the period ended Dec. 31, 2021, Aurora has managed to realize annualized run-rate cost savings of $60 million and expects to hit its original target of $80 million by the first half of fiscal 2023.
Its second-quarter results weren’t encouraging. Total revenue declined 10% year over year to 60 million Canadian dollars in the quarter. Aurora’s cost savings have helped the company reduce its earnings before interest, tax, depreciation and amortization (EBITDA) losses from $80 million Canadian dollars in the second quarter of fiscal 2020 to CA$9 million in fiscal Q2 2022.Â
Wounds haven’t healed yet
While the company is still struggling, it recently announced the acquisition of TerraFarma, the parent company of Thrive Cannabis. Management’s intention behind this is simple: Thrive has been EBITDA positive for the last 12 months and has an award-winning innovative products portfolio that will be helpful to Aurora. It is a “margin accretive transaction,” meaning the transaction of CA$38 million in cash, Aurora’s common shares, and two earnout amounts, (either in cash or Aurora shares whichever the company decides) will be based on if Thrive achieves certain revenue targets within two years of the closing. The deal is expected to close in Aurora’s fiscal fourth quarter of 2022.
Even though Aurora’s cost-cutting strategies seem to be working for now, until the company manages to grow revenue, profitability is still a long shot. Aurora’s management expects that when both companies combine their resources, strategies, and products, they could create something better. I see both positives and negatives in this acquisition. Aurora expects cost synergies from the acquisition to drive the company toward positive EBITDA by the first half of fiscal 2023.
Cost synergies are cost reductions that the company achieves from a merger by taking advantage of each company’s efficiencies. These efficiencies usually include high-class production facilities, competitive innovative products, growth strategies, the scale of operations, and more to generate higher sales. But this could take a while. A merger usually takes longer to show its true potential. Given Aurora’s current financial situation, it would weigh more on its balance sheet. The company has already been raising money through excessive share dilution, which doesn’t sit well with investors.
On the plus side, Thrive may be able to help Aurora with its recreational cannabis business. Lack of capital didn’t allow the company to develop any new recreational products — high-margin derivatives in particular. Derivatives are additional recreational products that Canada legalized in October 2019 as part of “Cannabis 2.0” legalization. With Thrive’s already established Greybeard brand, Aurora might be able to grow its Canadian recreational business. Management stated with this acquisition the focus is to now develop “innovative premium products including dried flower, pre-rolls, vapor products, and concentrates.”
Only time will tell
If Aurora management’s predictions are correct, then Thrive Cannabis could help boost the company’s revenue and help it achieve profitability. We will have to wait and see whether this acquisition will help Aurora rebound sooner.
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While Canopy and Tilray are getting ready to take advantage of the U.S. cannabis market, which is burgeoning right now, Aurora has a lot to deal with. Financially it is not sound or stable enough to expand into a highly competitive U.S. market. Aurora’s stock is down 32% so far this year, compared to the S&P 500‘s fall of 7%. Until Aurora shows some robust growth numbers, it might be wise to steer clear of this stock and consider other outstanding marijuana stocks.
This article represents the opinion of the writer, who may disagree with the âofficialâ recommendation position of a Motley Fool premium advisory service. Weâre motley! Questioning an investing thesis â even one of our own â helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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