When a stock has lost 80% of its value since last March, and with some analysts forecasting another 50% decline from here, we need to be careful if we want to jump on this.
For whatever reason, cannabis stocks have captured the attention of investors in a way that is entirely disproportionate to their size and standing. This especially includes the media, and you would think that cannabis is big business from seeing all the attention it gets in the financial media these days.
It is not that there aren’t at least some reasons for this, with this being such a relatively new business which formerly was controlled by some very wealthy drug lords and their minions, which may help build our illusions. It’s not that the shady side of this business has gone away, and they still control about half of the cannabis market in Canada, but legal cannabis has been catching up and is about to pass them.
The name that the substance that is used has even been cleansed, as this was primarily known as marijuana up until the legal stuff emerged, in addition to a number of other names that have been used over the years. Legalization has also seen the term pot make a big comeback, even though it hasn’t been called that on the street since the 60’s, telling us that certain commentators aren’t anywhere as hip as they pretend to be.
Perhaps cannabis makes sense though, given that still calling it marijuana may evoke images that some people want to avoid, especially the illegality part. We obviously are shooting for as clean a break as we can, given that this is a substance that so many people have been thrown into jail over selling, and now governments not only are allowing it, they have become the dealers themselves in some jurisdictions.
Over the years, a few politicians admitted to smoking marijuana, but allegedly didn’t inhale, which is pretty amusing since it was no less illegal to just blow it out. Why anyone would smoke marijuana and not inhale wasn’t explained though. Canadian politician Justin Trudeau was honest enough to admit he did inhale and he even liked it, so once he became Prime Minister, the game was on.
This turned out to not quite be the land of milk and honey that governments and companies had envisioned, even though governments in particular are going to naturally lean on the side of overpromising when they take such a big step. The companies spoke too loudly as well, and that’s natural as well given that they want to pump up their stocks.
Among these companies is Aurora Cannabis, who had been selling to the Canadian medical marijuana market and stood proudly alongside their competitors as well as with a number of new companies looking to cash in on this perceived bonanza. The stock market bought the hype as it turns out, and this at least contains some key ingredients that a lot of speculative investors like, particularly the opportunity to get in on the ground floor of an industry with real potential for growth.
An industry growing and company profits growing isn’t always the same thing though, and there has been a key ingredient missing in this story, the fact that this only works when you make money.
Once the legalization in Canada was announced, Aurora’s stock quintupled over a period of just a few months based upon all this hype, and while this overexuberance was quickly rectified, it took a couple more shots at these heights, with one attempt as late as the first quarter of 2019. It has now fallen all the way back down to its original level prior to the announcement, to where it was back when it was just a medical marijuana supplier.
Cannabis is Not a Nascent Market by Any Means
While we may be tempted to think that this is a new market which takes time to develop, while calling it cannabis may be new, the stuff itself has been around for a very long time and for sale all that time as well. While there was an expectation of growth that still persists, the majority of the market for cannabis was already in place, where they would now just buy it legally instead of on the street.
Investors approached this in the way they might with a company like Tesla, looking to capitalize on the transition to electric cars that we are expecting, and being willing to overlook losses as these little trees try to grow into full size ones. These were mature trees on the landscape with cannabis companies though, and while growing pains were expected, continuing to lose money just doesn’t fit with being excited.
While it may be fine to want to be in a stock that is experiencing growing pains itself, we need not ever be too impatient with these stocks, as when the sun starts to actually shine on them, we will know, as we did with Tesla in their unbelievable run up over the past few months. It’s just better to be on the train when it is ready to finally leave the station instead of being stuck on it and take on all the risk without enough indication it will be worth it.
We don’t have to be quite at the level of profitability for the train to really begin its journey, but we at least need to see it on the visible horizon. That’s what happened with Tesla, and after a decade of doing nothing but lose money, they might have their first profitable year ever in 2020, and just knowing this can be enough.
Seeing nothing but red as far as the eye can see, as is the case with Aurora, isn’t the ideal time, especially when we’re in a mature market with enough time for them to adapt to it. Aurora is being forecast to continue to lose money through fiscal 2022, which also happens to be as far as people have looked.
Fiscal 2022 is at least expected to get them closer, with only a 3 cent per share loss forecasted for that year, which is 10 cents per share better than the average of 2020 and 2021. Still though, after all this time, if that’s the best they can do, we at least know we’re not dealing with any sort of growth that anyone should find exciting, even among those under the influence of their products.
The outlook for Aurora has become so bleak now that even their attempting to sell one of their non-operational greenhouses that they acquired in a prior acquisition was seen as a negative and even had some people wondering whether this meant that the end is nigh. The only questions that this should have brought up is why they took so long to try to dispose of it, along with whether it was wise to acquire assets like this in the first place.
It is clear enough that Aurora has not been a well-managed company though, and we should be glad when we see company officers leave, but the departure of their chief corporate officer was also perceived as a negative by the market.
They have not made the inroads into the Canadian cannabis market that many had hoped, and continue to rely on their medical marijuana business far too much, even though legalization has thrown it into decline. Much of this dispensing historically was to recreational users who would just walk into a medical clinic and be handed prescriptions on demand, but these folks can now just go to their neighborhood cannabis store without needing to bother with this extra step, as can everyone now.
We are at least seeing them make more of a showing at these stores now, but at a time where competing brands have already built enough of a following to leave them still behind. When you have to hope that potential customers will see your product through the glass and be curious enough, that’s not a lot to rest your hopes on too much.
Aurora Cannabis stock has now been beaten up so badly that they are starting to attract some vultures. Perhaps not vultures but at least one vulture, as there is one analyst that is thinking that we have hammered this stock enough and the $2 area may be a good time to jump in.
While Aurora is down 80% over the last 10 months, it has come up a little off the bottom it put in on January 10 at $1.65 per share, and has peeked above $2 once again. That’s a 24% gain in less than 2 weeks, which might even excite us a little until we look at the chart and see many of these moves during their journey downward lately.
Cantor Fitzgerald Analyst is Ready to Jump on this Very Sick Horse
Pablo Zuanic of Cantor Fitzgerald believes this just won’t be another little pause on a journey further downward, even though other analysts see this stock dropping all the way to $1 per share, half of the $2 it sits at now. Given that analysts are naturally optimistic, especially with beaten up stocks, when they get this pessimistic, this really needs to be taken seriously.
Zuanic does not want to be part of that gang though and feels that Aurora Cannabis’ “recent stock decline is a reaction to analyst downgrades and misperceived matters.”
There is at least some truth in this, and if you are a fundamental analyst, this massive move down must surely look overdone, because things really haven’t changed that much when the stock was trading at $10 per share less than a year ago. A move like this normally involves some serious deterioration of a company’s business, but this company has been beating expectations since their miss in March 2019 that started this big slide.
Losing 8 cents a share back then when the street was only expecting 3 cents does perhaps deserve some punishment, but you would think that it has been punished enough for this already, especially since it posted a flat quarter and one that even made a penny since, where analysts were expecting a loss of 2 and 3 cents respectively.
This is only part of the story though even though its front-page news with fundamental analysts. The market wasn’t made too happy by these past 2 quarterly results though, and when you beat expectations but remain in free-fall, that does not bode well and there really isn’t that much to hang your hopes on other than the hope that enough blood has been spilled already.
That actually may end up being the case, but given the risk, we at the very least need to proceed very carefully. Aurora’s next quarterly report is expected on February 10, and the consensus forecast is for a loss of 4 cents a share, the same as this period last year. Even if they beat this, it won’t be by much, and while the company will surely continue to try to put a positive spin on things with its guidance, this ship isn’t really headed anywhere good for as far as the eye can see, so that should not matter much.
People become tempted by bottom plays like this more than they should, from looking at a play too much in isolation rather than comparing risk and return with competing stocks as it would be sensible to do. They may even look back upon some of these plays and see some work and lament that they didn’t have the courage to act, ignoring all the extra risk that this involved, and then taking on too much the next time and paying the price for it.
The fact that Aurora has a lot of potential upside here is something that isn’t even disputable. There simply aren’t a lot of stocks that have gained 24% over the past two weeks, and just getting back to where this stock was last September would provide over a 300% gain from here. The S&P 500 has not gained this much over the last 10 years of a huge bull market, but Aurora has the potential to do this in months, not a decade.
Fundamental analysts don’t really account for stocks being oversold all that much, and even tend to ignore market behavior, as foolish as that may be, so Zuanic deserves a lot of credit for accounting for this phenomenon. It’s hard to imagine how fundamentals could drive this all the way down to $1 a share since they remain stable, and even remain similar to where we were back in September when we were over $6 a share.
The market action could certainly drive them to $1 or lower though, and we’re trending that way as well, and this is ultimately the level where these decisions are made, for whatever reason. On the other hand, this force does get overexpressed, where people get out due to fear, and once the fearful people are gone, this is the point where the optimists can start to take over if there are enough of them.
Stocks continually move from overbought to oversold conditions and back, and this is certainly a situation we need to call oversold, with nothing much changing other than the stock tanking. At some point, this stock will come back by a meaningful amount, more than just the little blip up we just saw, and may indeed double in value or more at some point just to reach equilibrium when the downward pressure of so many people running for the exits subsides because so many of them have left.
The real question is whether we have hit this point now, although this would be the first real time that we would even want to think such a thing during this massive selloff. There surely has been a number of bottom feeders that have been handed their lunch for being too eager up until now, but as long as they haven’t been too stubborn and did bail when their idea did not pan out, even this risk could have been contained decently enough.
When we look at the recent history of Aurora’s trying to rise up and then falling back down, we do see a decent margin of safety here between when the move stops and when further losses mount, which is important given that if we enter here, we could easily give back the 24% that it just gained and plenty more if we are not careful.
A common rule of thumb is to set your stop below the previous low, but that’s just too dangerous here given that this would represent such a large loss that could be upon us pretty quickly. Doing this in this case would be simply asking for a whole lot of trouble, and if we really do want to take a shot at this, our exit criteria will have to be much tighter.
Having to do so can make a play unattractive in itself, as we now risk getting taken out just by the noise, normal variations in price movement that aren’t really significant to where the stock may be headed. This is why below the low works generally, as if we get there, the time is not now and we are being shown we have been wrong enough to want to flee, but can still hang around to be able to reasonably be able to tell.
This is therefore a very tricky play and one that will need a very tight stop if we are daring enough to take Zuanic’s advice and get in now. Trading is all about the risk to reward ratio though, and when we consider how much bigger the upside is than the few cents that we can risk with this, as long as we’re prepared to take the loss if our timing isn’t right, this can still be well worth it.
We are talking about a tight stop indeed here, not much below $2, where the chances of losing a nickel on this are pretty high, but the much bigger payoff if this does turn out to be the right time is so much larger that we could do several of these in a row before we hit and still end up in a nice place overall.
The alternative is to wait until it trades over $2.16, which is also a more sensible approach since it will have shown us more that it is ready than where we are at right now. This is also a better strategy if we are actually looking to invest in the stock and not just trade it, because we need more confirmation with investing since we need to let the play breathe more, but not too much.
This stock needs to be approached with much caution whether you are trading or investing, and investors really need to approach this pretty close to the way a trader would if they do not want to get soaked if it starts raining again. We need to remember that even if we are investing, we can always go back outside when the rain stops, and being under shelter when it rains as hard as it has with this one can be a very good idea indeed. Just ask the people who have been out in the rain since last March.
The earnings call two and a half weeks from how also adds risk to the play, and those who really want to keep the risk of this down will wait for both the call and the move above the resistance at $2.16, which we already failed to get past once this year already. Should the call disappoint, the best we will be able to do is deal with the aftermath the next morning, after whatever gap down this causes is already in the books. Having a full quarter to not have to worry about such a thing can be a real nice to have.
Overall, this truly is an interesting play even though this stock has been so utterly horrible recently. Zuanic may have spotted a good bottom play here, and his current target of $5 a share may indeed be realistic, but as they say, timing is everything.