Shares of Aurora Cannabis (ACB) surged by over 260% shortly after the company posted a Q3 FY20 revenue beat last month. But that, in itself, doesn’t mean the company is out of the woods yet. Latest data actually reveals that short interest in the scrip rose once again, while its shares were rallying in the second half of May. The emboldening of short-side market participants suggests that Aurora’s shares have significant downside from its current levels and that the scrip is going to be volatile in the coming weeks.
(Image source)
Shorting Intensifies
For the uninitiated, short interest is the total number of short positions that are open and are yet to be covered. A sharp rise in the metric implies that traders have stacked short-side bets, expecting the concerned security to depreciate in value in the near future. Conversely, a sharp decline in the metric suggests that market participants actively wound up their short positions in the last cycle as, perhaps, they feel the stock is fairly valued and doesn’t have much downside in store in the near future. So, short interest is essentially a tool to gauge the Street’s sentiment relating to any given stock.
Coming to Aurora Cannabis, its short interest stood at 21.87 million shares at the end of the last cycle. This meant the metric increased by about 0.58 million, or about 3%, on a sequential basis. The figures may not seem much in isolation so let’s put things into perspective. The cannabis producer has about 112 million shares outstanding which means about 19.4% of its entire share count stood shorted at the end of the last cycle – its highest level since IPO.
Data by YChartsSure, the 3% increase in its short interest number doesn’t ring any alarm bells in itself. But what’s surprising is that Aurora’s shares rose by about 260% and its short interest rose along with it. It was previously hypothesized that the dramatic surge in the cannabis producer’s stock price would have burnt short-side market participants and forced them to close their positions at a loss. But the 3% rise in Aurora’s short interest suggests that short-side market participants were only emboldened as the stock rose in value and that the rally only drove them to stack even more short positions.
I looked at industry comparables to put things in perspective. As it turns out, Aurora’s short interest as a percentage of its overall shares outstanding, was higher than all the other mentioned peers. This suggests that Aurora Cannabis, in particular, has become quite a popular name in shorting circles. It seems like short-side market participants are forecasting the stock to considerably depreciate in value in the near future, which doesn’t come across as an encouraging sign for long-side investors in the scrip.
(Data from YCharts, chart compiled by author)
But this begs the question – why are these market participants bearish on Aurora Cannabis in the first place?
Reasons for Bearishness
Several Seeking Alpha contributors have already discussed how Aurora Cannabis posted a strong set of quarterly results, so we won’t be covering the same points again. Analysts, too, raised their full year revenue estimates for the cannabis producer in the weeks following its earnings release. But the ground reality is that the cannabis producer is priced at a premium compared to its peers when factoring in FY21 revenue estimates.
(Data source: YCharts, chart compiled by author)
This discrepancy suggests that Aurora’s shares have risen disproportionately higher than they ideally should have. Sure, the cannabis producer may very well stage a turnaround in the coming quarters. But that turnaround hasn’t happened yet and the dramatic rally in its shares suggests that a lot of its future growth has already been priced in.
So, I personally believe the cannabis producer’s shares are bound to correct by 15-20% over the coming weeks to be fairly valued, when its forward P/S multiple comes in line with its mentioned peers. But having said that, Aurora’s lofty valuation is probably why short-side market participants were emboldened in the last cycle.
Moving forward, Aurora Cannabis announced earlier this month that it’s selling its 23% stake in Alcanna for $27.6 million. This seems like a great move at the first glance – Aurora Cannabis gets to shed a non-core asset and also generate much-needed cash along the way.
But things are not that straightforward. The chart below reveals that Alcanna is much bigger than Aurora in terms of revenue generation. Also, note that Alcanna is grossly undervalued compared to Aurora Cannabis. If the latter still goes on to sell its stake in the former, especially at an 80% loss on its original investment, then that reeks more of desperation than is coming across as a strategic move.
(Data source: YCharts, chart compiled by author)
This fire sale casts doubt on Aurora’s financial health and also raises the question – How many more deeply discounted divestments would Aurora have to carry out in order to stage a successful turnaround? Managements of companies that are on the verge of turning things around, generally plan their moves strategically and have the bigger picture in mind.
But Aurora’s fire sale suggests that the company’s management is really desperate to generate cash, to sustain their operations long enough for their business transformation to be complete. Given its dire financial positioning, there’s the risk that any wrong move on its management’s part can drive Aurora into bankruptcy. In light of this risk factor, I expect shorting activity in Aurora Cannabis to remain at elevated levels and I also recommend long-side investors reassess their bullish stance on the cannabis producer.
Final Thoughts
The key takeaway here is that Aurora Cannabis’ shares have risen too much, too quickly, and they’re likely going to correct in the coming weeks to regain touch with reality. So, investors who are already long on the name, may want to sell their positions in the cannabis producer while its shares are still high. Risk averse investors, however, may want to avoid the stock altogether given its risk profile and uncertainty about the future. Good Luck!
Author’s Note: I’ll be writing another report on Aurora Cannabis later this month, you can stay updated by clicking the “Follow” button at the top. Thanks!
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.
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