Aurora Cannabis Inc. (ACB) may appear undervalued relative to where it was, but what looks like a value opportunity can sometimes be a value trap. And in the case of Aurora Cannabis, a stock that is down 87.96% from its 52-week high of $86.40, a value trap is what we seem to have.

At close of market on 07/24/2020, Aurora Cannabis traded at $10.40 per share. Chart generated by FinViz.

At close of market on 07/24/2020, Aurora Cannabis traded on the New York Stock Exchange at a share price of $10.40 with a price-to-earnings ratio of 48.15, which is a significant discount to its five-year average P/E of 149.97. However, the current P/E does not seem cheap at first glance, prompting the question of what fair value for Aurora Cannabis is.

To determine fair value, I will first divide the current P/E by the historical market average P/E of 15 to get a valuation ratio of 3.21 (48.15 / 15 = 3.21) and divide the current share price by this valuation ratio to get a first estimate for fair value of $3.24 (10.40 / 3.21 = 3.24). Then I will divide the current P/E by the five-year average P/E to get a valuation ratio of 0.32 (48.15 / 149.97 = 0.32) and divide the current share price by this valuation ratio to get a second estimate for fair value of $32.50 (10.40 / 0.32 = 32.50). Finally, I will average out these very different estimates to get a final estimate for fair value of $17.86 (3.21 + 32.50 / 2 = 17.86). On the basis of this estimate, the stock is undervalued by 42%.

A stock trading at a 42% discount to fair value seems enticing, until you look at how profitable the firm has been. While revenues have grown each consecutive year, 2018 is the only year in the past five years that Aurora Cannabis has made a profit.

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Year Revenue (CA$) Revenue ($) Net Income (CA$) Net Income ($)
2015 -9.52 million -7.10 million
2016 1.44 million 1.07 million -5.72 million -4.26 million
2017 18.07 million 13.47 million -12.97 million -9.67
2018 55.2 million 41.15 million 71.94 million 53.63 million
2019 247.94 million 184.83 -290.84 million -216.81 million

Figures collated from annual reports available on Aurora Cannabis’s investor relations page.

The current financial year does not look to be any better, particularly with an operating margin of -106.78% and reported negative free cash flow of -CA$142.63 million.

2020 Quarter Revenue (CA$) Revenue ($) Net Income (CA$) Net Income ($)
Q1 75.25 million 56.10 million 12.76 million 9.51 million
Q2 56.03 million 41.77 million -1.29 billion -960 million
Q3 75.52 million 56.30 million -137.4 million -102.43 million
Total 206.8 million 154.16 million -1.42 billion -1.06 billion

Figures collated from quarterly reports available from Aurora Cannabis’s investor relations page.

Aurora Cannabis’s balance sheet looks strong enough that it could potentially weather the COVID-19 storm, as long-term debt of CA$539.06 million ($401.86 million) is offset by a net worth of CA$3.90 billion ($2.91 billion), and total current liabilities of CA$206.44 million ($153.90 million) are offset by total current assets of CA$654.25 million ($487.73 million), cash-on-hand worth CA$230.21 million ($171.62 million), short-term investments worth CA$11.83 million ($8.82 million), and total accounts receivable of CA$80.35 million ($59.90 million). And perhaps it could – if COVID-19 was all Aurora Cannabis had to worry about.

Aurora became prominent as one of the largest producers of marijuana when the pot market took off in 2017. However, interest has waned considerably since then, and Aurora’s productive capacity became a liability as it was oversupplying to an undemanding market. In consequence, it is in the process of laying off 700 employees (production staff, sales and administrative staff, etc.), shutting down five of its Canadian production sites, has suspended construction of two larger production sites, and sold its 1 million square foot Exeter greenhouse for CA$8.6 million ($6.41 million) – far less than the original purchase price of CA$26 million ($19.38 million).

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Aurora Cannabis will likely have to divest assets at a reduced price. Image provided by the Financial Post.

Put simply, Aurora Cannabis has too many unused assets on its books at present, and shifting them at a price that will get a profit in the current economic environment is a fanciful notion at best. The cash burn that these unused assets will cause will inevitably dent the balance sheet, and the sub-par returns they get for those assets which they do manage to sell will not redress the balance.

Present investors have not enjoyed much profit from their holdings in this stock either, judging from the -33.98% return on equity. And while a stock trading 87.96% lower than its 52-week high and at a 42% discount to fair value may look attractive at first sight, Aurora Cannabis’s unused assets will only hurt prospective investors in the long-run. In short, this is one to avoid.

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.