Is Sundial Growers Stock a Buy Despite the Heavy Dilution?

Sundial Growers (NASDAQ:SNDL) reported its third-quarter results on Nov. 11. Hidden among the various financial details was a note that the company plans to consolidate Sundial Growers stock to remain in compliance with Nasdaq listing standards.

Marijuana plants growing in a greenhouse.
Source: Shutterstock

Trading at 25 cents as I write this, it will most likely have to do a reverse split of at least 10 shares to get its share price safely above $1. A multiple of 20 might make even more sense because that would get it above $5, below which it’s considered a penny stock.

As of Nov. 9, Sundial had 439 million shares outstanding, increasing more than two-fold since the end of September. I’ll get to that discussion in a moment. With a 20-for-1 reverse split, its shares outstanding would be just under 22 million.

The company is currently walking a fine line between keeping its shares listed on Nasdaq, adding backbreaking debt to finance growth, or diluting shareholders to an even greater extent than it already has.

What does this mean for current and future shareholders? Let’s have a look.

The Share Count for Sundial Growers Stock Is Increasing Rapidly

As I said previously, the company’s share count increased exponentially after the September quarter-end. On Sep. 30, 2020, it had 206.7 million shares outstanding. Almost six weeks later, that figure had jumped to 438.7 million.

How did it get there? It converted a whole bunch of convertible debt into equity while also doing an at-the-market (ATM) offering to raise more cash to fund its growth strategy.

The ATM offering raised $35.5 million at an average price of $0.291, adding 121.9 million shares to its capital structure. A combination of converting convertible notes to equity and warrants to equity added 108.5 million shares, bringing the total to approximately 439 million.

So, if you owned 1% of Sundial’s stock at the end of September (2.07 million shares), thanks to its equity raise and conversion of debt, you owned less than 0.5% of the company on Nov. 9.

That’s not the end of the world. Here’s why.

A Strengthened Balance Sheet

The various moves it made from Oct. 1 onward generated $36.9 million for Sundial’s cash account. It reported in its November press release that it had 60 million CAD in cash on hand. That would make sense, given it had a little more than 21 million CAD at the end of September before it added the funds from its ATM offering.

Sundial stated in its Q3 2020 press release that it decreased debt by 23 million CAD in the quarter and by more than 100 million CAD in the first nine months of 2020.

“While our third quarter revenue decreased, we are pleased with the demonstrated improvement in operating discipline, successful cost optimization initiatives and a material reduction of our debt,” said Zach George, Sundial’s CEO.

“… Having entered 2020 with a challenged capital structure, and a disparate business model, our team has moved aggressively to focus our operations and product portfolio to get the very best from our high-quality people and assets.”

At the end of December 2019, Sundial had almost 178 million CAD in debt outstanding with no convertible notes. At the end of September, it had 71 million CAD in debt and another 48 million CAD in convertible notes for a total of 119 million CAD in debt.

As of Nov. 9, its debt was 127 million CAD, including 55 million CAD in convertible notes and 72 million CAD in syndicated bank debt. More importantly, it’s reduced its annualized debt service costs by 31 million CAD due to the restructuring it began in June.

Yes, I’d say its financial position is much stronger than it was at the end of 2019.

The Revenues Weren’t Terrible

Sundial’s reorganization moves the company from a wholesaler of cannabis to a focus on branded retail sales. Its quarterly sales are expected to decrease as it reduces its reliance on wholesale business as it transitions.

In the third quarter, its branded net cannabis sales accounted for 77% of its overall revenue, up from 69% in the second quarter. Its branded net cannabis sales in the third quarter were 9.9 million CAD, 29% lower than in Q2 2020.

The company continues to consolidate the number of products sold to focus on those SKUs generating customer interest. By doing so, it expects to grow sales in the future without sacrificing its pathway to profitability.

When you consider that it had no vape sales in the first nine months of 2019 but managed to generate 14.2 million CAD in the first nine months of 2020, including 3.6 million CAD in the third quarter, it’s a glimmer of hope for Sundial’s future sales.

On Nov. 9, Sundial announced that it had entered into a sales and distribution agreement with Choklat Inc., an Alberta-based company that produces craft chocolate confections.

“Sundial and Choklat will launch a cannabis-infused confectionary brand, offering a selection of chocolate bars, drinking chocolate and infused sugar, all containing 10 milligrams of THC, the highest amount legal to sell in a single edible serving in Canada,” Sundial’s press release stated.

“Both companies expect to scale the collaboration across the country with first product targeting to be in-stores ahead of the holiday season in Alberta.”

The Bottom Line

I don’t think there’s any question that Sundial Growers stock is a speculative bet. There’s a lot that has to go right for its business model to play out successfully.

Currently, as Canaccord Genuity analyst Matt Bottomley points out, Sundial’s cash cost per gram is above 2 CAD, while the industry average is under 1 CAD. As prices get more competitive in the Candian adult-use marketplace, it will become tougher for it to make a buck.

As for the dilution it’s undergoing at the moment, it’s a necessary evil until it can self-finance from cash flow or borrow at reasonable interest rates. Until then, it is what it is.

Sundial’s enterprise value is currently 2.5-times sales. The mid-tier average, according to Bottomley, is 4.5-times sales.

If you’re a very aggressive investor, I think management’s done enough in 2020 to justify investor consideration. Everyone else should stay away. The risks are still too high for the average person.

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

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