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Aurora stock rallying, but out-of-line valuation is a significant risk

Aurora stock rallying, but out-of-line valuation is a significant risk

The shares of Canada based medical cannabis producer and distributor Aurora Cannabis (NYSE: ACB) rallied more than 20% this week and extended the year to date gains to 90%, driven by several factors including the potential US cannabis legalization, increased institutional investors interest, and buying calls from Reddit day traders.

Aurora’s strategy of restructuring its business model and trimming its cost structure helped add to investors’ sentiments.

Aurora Cannabis stock performance. Finviz chart. See more stocks here.

Improving fundamentals are backing upside

Biden administration is seeking to lift the federal ban on cannabis. Recently, three senators, including Senate majority leader Chuck Schumer, said they would present “a unified discussion draft on comprehensive reform” in the Senate in the coming months.

The CEO’s of top-rated cannabis companies have also been forecasting US cannabis legalization in the short-term, with Canopy (NYSE: CGC) CEO David Klein expects decriminalization of the drug in 2021 while Tilray (NASDAQ: TLRY) CEO Brendan Kennedy anticipates cannabis legalization in the coming 12 to 18 months.

Tilray stock performance. Finviz chart.

Moreover, day traders sitting on social media forums have also focused on cannabis stocks, according to Reuter’s report. Buying calls from Reddit users pushed Tilray stock price 50% higher in Wednesday trading. Tilray is among the hottest stocks amid reports regarding its merger with Aphria (NASDAQ: APHA).

Out-of-line valuation is a major risk

Aurora, which is struggling to generate profitability, could face challenges in sustaining the stock price gains in the long-term amid out of line valuations, according to BMO analyst Tamy Chen.

The shares lack support from real-time numbers, and the upside momentum is only built on speculations and expectations. Aurora Cannabis stock is trading around 9 times to sales and 36 times to earnings compared to the industry average of 1.19 and 18 times, respectively.

After missing the 2020 profitability target, its 2021 first-quarter revenue fell 8% year-over-year while adjusted EBITDA loss came in at $57.9 million. The company blames market uncertainty for higher than expected losses. It has yet to provide new profitability guidance.

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