Shares of Aurora Cannabis (ACB) are down by about 65% in the last three months alone but the downtrend could still continue. Latest data reveals that short interest in the name surged by over 13% in the last cycle. While this sharp rise won't trigger a downside in Aurora’s shares in itself, it does suggest that a broad swath of market participants is anticipating a major decline in the cannabis producer’s shares in the near future. It signals a larger problem with Aurora’s growth story and should come across as a concerning development for the company’s long-side investors. Let's take a closer look.
The Shorting Story
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 indicates that bears are stacking short positions in hopes of the concerned stock to fall in the near future. Conversely, a sharp drop in the figure indicates an active short unwinding as, perhaps, market participants feel the concerned stock is fairly valued. So, short interest can be viewed as a tool to measure market sentiment.
If we talk about Aurora Cannabis, its short interest surged by nearly 20 million in the last reporting cycle alone, marking a considerable increase of 13.3% on a sequential basis. The company has around 1.31 billion shares outstanding which means that over 16.5% of its entire share count stood shorted by mid-April.
A modest change in Aurora’s short interest could have been explained by hedging-related transactions. However, a massive 13.3% jump in the company’s short interest, within a span of just two weeks, leaves little doubt that market participants are actively shorting the stock due to its deteriorating financial and operating position.
The strange part here is that Aurora’s shares have been trending down for several months now. This should have ideally prompted more and more short-side traders to unwind their short positions and book profits. But the opposite happened and shorting activity in the name actually increased. This suggests that short-side market participants are anticipating Aurora's shares to decline even further in the near future.
Also, short interest in Aurora Cannabis surged in the last cycle when its shares were trading between the $0.7 and $0.8 range. A build up of short interest in this cycle suggests that market participants perceived the stock to be overvalued in this price range. The stock is still trading within the said price-band which, in turn, suggests that the Street’s bearish sentiment pertaining to the scrip could still be intact. This begs the question – why are market participants shorting Aurora’s shares at all?
Looking Under The Hood
The Canadian retail industry has been rife with challenges of late. I've discussed in my prior articles how retail side bottlenecks and lackluster demand have limited sales growth across the country. Although hopeful bulls negate these concerns, I believe it could take several months for new stores to be operational and commercially viable to drive industry-wide sales growth. Besides, there's no telling how long will it take for legal recreational cannabis demand in Canada to accelerate like it did in the past.
Latest sales trends bring these concerns to light. Retail cannabis sales across Canada dropped by 2.8% in February on a sequential basis. The sales drop, in itself, isn’t catastrophic for major cannabis producers such as Aurora Cannabis but the sales drop highlights the disparity between the hopeful bull thesis and the ground reality. It's unclear at this point in time why industry sales are stagnating -- is it due to retail-side bottlenecks or illegal product being more competitive?
Moreover, Aurora Cannabis announced a reverse split on April 13. I had predicted this would happen during March, and also conducted a study which revealed that stocks that undergo reverse stock splits are likely to see their share price decline in the subsequent one year. This probably explains why we saw a surge in Aurora’s short interest in the last cycle.
Having said that, there aren’t any material growth catalysts lined up for Aurora Cannabis that would invigorate growth and fuel a major stock price rally. The company has already seen three of its four revenue streams shrink during Q2 FY20 and I suspect that the logistics and supply-related bottlenecks caused by the coronavirus outbreak would only exacerbate Aurora’s financial woes by shrinking its international and wholesale revenue streams.
The cannabis producer’s Q3 usually ends on March 31 and it’s possible that its revenue for the quarter could take a hit due to restrictions on travel and logistics, imposed during March. Aurora’s international revenues could suffer due to the closure of international shipping ports while its domestic recreational sales may be hit due to the closure of brick and mortar stores. Only time will tell what the ground reality really is, but for now, these factors seem like a legitimate risk factor for the company, and it was probably also a contributing factor to its rising short interest figure.
Final Takeaway
A material rise in Aurora's short interest doesn't guarantee a decline in the security's price. In fact, if the company issues a positive announcement in the coming few weeks, we might as well see a short squeeze as short-side market participants would want to unwind positions as quickly as possible.
But having said that, I believe that risk-averse investors should remain on the sidelines and avoid investing in the stock altogether. It's a volatile stock to own due to the given uncertainty surrounding its prospects, and the buildup of short interest suggests that all's not well for the company. Hence, trying to find a bottom to its shares might just be akin to catching falling knives.
Good Luck!
