It’s been a year since the irrational exuberance related to cannabis stocks was replaced by caution and reality check. Over the one-year period, Tilray (NASDAQ:TLRY) stock plummeted by 85%.
The stock decline is a reflection of multiple industry headwinds coupled with weakening company fundamentals. Even at current levels of $7.50, I remain cautious on TLRY stock. I believe further downside is likely in the coming quarters.
It’s worth noting that for fiscal year 2019, Tilray reported revenue of $167 million. Revenue was higher by 3.9 times as compared to the prior year. Stellar revenue growth seems like a big positive. However, there are two factors that need to be considered.
First, the acquisition of Manitoba Harvest triggered revenue growth with the addition of the hemp segment. Second, revenue growth in the cannabis segment was primarily driven by the sale of dried cannabis. Medicinal and recreational cannabis products, which command high margin, didn’t see growth.
Cash Burn Would Imply Further Equity Dilution
One of the biggest concerns for Tilray is the rate of cash burn and its implications. Recently, Tilray received gross proceeds of $90.4 million from a Class 2 common stock offering. This implied significant equity dilution and TLRY stock reacted negatively.
The concern is that there can be further equity dilution coming in the next 12 to 18 months. This will keep the stock depressed even if revenue growth is robust.
Tilray reported cash used in operations of $258 million for the last financial year. For its 2018 fiscal year, cash used in operations was $46 million. Clearly, cash burn as accelerated even as revenue growth was robust. The company’s cash used in investing activities was also high at $253 million for the last year. Overall, the company used cash of $511 million.
This is important to mention because Tilray reported cash and equivalents of $97 million as of December 2019. The recent equity issue implies that the cash position is bolstered to $200 million. However, even if cash used in operations is at the same level as last year, the company would need additional funding. And I am still not talking about the capital expenditure for the current year.
Therefore, cash burn is the biggest challenge that needs to be addressed. Unfortunately, positive free cash flows are not on the horizon.
A Slow Growth Strategy
Tilray is focused on building a global platform for growth. The company has cannabis distribution presence in 15 countries and hemp distribution in 20 countries. However, a slow growth strategy is needed to arrest the cash burn than aggressive expansion.
For the last year, the company’s sales and marketing expense was $61 million as compared to $15.4 million in FY18. Similarly, general and administrative expense was $81.9 million as compared to $29.4 million for the same periods. Surge in these expenses have contributed to an increase in cash burn.
It’s worth noting that growth in medicinal cannabis is unlikely until the clinical trials establish the effectiveness of cannabis drugs. Tilray is participating in several clinical trials, but the process is long. It further involves cash burn. Trying to expand into multiple countries without the Food and Drug Administration approved drugs is unlikely to yield results. Till date, the FDA has approved only one drug for the treatment of severe forms of epilepsy.
In the recreational cannabis segment, Tilray plans to introduce new forms of vapes, edibles and beverages. For these products, the market response remains to be seen. However, there can be a potential positive trigger if these high margin products gain sales traction.
As a matter of fact, Aurora Cannabis (NYSE:ACB) launched cannabis 2.0 products in December 2019. The products include vapes, concentrates, gummies, chocolates, baked goods and mints. These products are possible EBITDA margin game changers. While it’s too early to conclude on the response, Aurora stock has continued to trend lower. This might be an early indication of limited success of products.
My Concluding Views on TLRY Stock
I believe that cash burn and further equity dilution will continue to take TLRY stock lower. The company needs to formulate a strategy to reduce the cash burn and focus on few markets. It’s unlikely that strong global growth is coming soon. Therefore, the focus needs to be on survival and clinical tests that establish the medicinal benefits of cannabis.
From an investment perspective, the TLRY stock is likely to remain sideways or trend lower. With no positive trigger on the horizon, investors can avoid the stock even after the deep correction.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
