The cannabis industry is going to see a shakeout, and I don’t expect Sundial Growers (NASDAQ:SNDL) will be immune. The question is less if Sundial Growers stock will be affected than how.
The simple problem for Sundial and the Canadian cannabis industry is that there are too many growers, too many companies, and still too much production. That’s going to leave companies going bankrupt, a process that already has begun.
It’s also going to lead to consolidation in the sector. That process, too, has started. The recently announced merger of Aphria (NYSE:APHA) and Tilray (NASDAQ:TLRY) is the largest tie-up so far — but it almost certainly won’t be the last.
Sundial could follow either of those broader trends. The company could be a potential takeover target. Its attractiveness has only improved thanks to smart moves by management over the past few months. Recovering sentiment toward the sector doesn’t hurt, either.
That said, the company isn’t out of the woods. Past rallies in both SNDL and cannabis stocks more broadly have eventually reversed. There’s still a chance that Sundial Growers stock winds up at zero. SNDL probably is worth the risks at this point, but it’s worth keeping those risks in mind.
An Improved Story
Coming into 2020, it was far from certain that Sundial would make it through the year without a restructuring. The company closed 2019 with 178 million CAD in debt and only 45 million CAD in cash. Sundial was in violation of covenants governing those borrowings. And with adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) sharply negative, there was a seemingly narrow path toward improving, let alone fixing, the balance sheet.
But Sundial has found a way. The balance sheet is in much better shape. In June, Sundial converted 73.2 million CAD of debt into convertible notes. It then exchanged stock for those notes. The sale of the U.K. business, Bridge Farm, further reduced borrowings. Thanks to a recent 50 million CAD prepayment, debt is down to 22 million CAD, with interest expense now less than 1 million CAD annually.
The risks still hold. After all, Sundial Growers stock has declined 85% so far this year. That hardly suggests that bankruptcy risk has been mitigated. This was supposed to be a better year for the industry, and even ignoring the effects of the novel coronavirus pandemic, it simply hasn’t met expectations. Sundial’s adjusted EBITDA remains negative. The company filed a shelf registration statement earlier this month which could allow for the sale of as much as $150 million of SNDL stock in order to raise much-needed capital.
The work isn’t done. But that doesn’t mean the work so far should be ignored.
Where Does Sundial Fit?
The improved balance sheet at the least gives Sundial more time. The company has the chance to start driving better growth and reach profitability on its own — or look for a partner with more capital.
To be clear, a near-term merger probably is unlikely. The industry does need consolidation, but potential buyers also do not have to be in any rush at the moment. That said, there is a case for Sundial Growers as a merger partner, if probably not an acquisition target.
After all, one of the core problems the industry is facing is a lack of profitability. Sundial itself has lost about 35 cents in EBITDA for every dollar of year-to-date revenue. Pricing pressure from a glut of production has offset improvements in growing costs, while operating expenses are too high against still-disappointing sales.
Mergers can attack both problems. Indeed, cost-cutting is a core rationale for the Aphria-Tilray tie-up. The same benefits for Sundial probably would hold: slashing the 25.5 million CAD in year-to-date general and administrative spending alone would make Sundial an accretive acquisition. That aside, Sundial’s higher-end portfolio could be attractive to another smaller rival.
With the balance sheet so significantly improved, this can work.
The Risks to Sundial Growers Stock
It bears repeating: there are risks. The balance sheet is better, but the business still is a long way from profitability. A merger is far from guaranteed, and even after the 85% YTD sell-off Sundial may simply be too expensive.
After all, Sundial has issued a significant amount of stock to retire the convertible debt and fund itself. A current share count near 744 million still values the company at about $330 million. That’s still more than 6x trailing 12-month revenue. That may be too dear a price for a merger partner or acquirer. Strategically, Sundial’s focus on “inhalables” may turn off companies still hoping for growth in “Cannabis 2.0” products like edibles and topicals.
Sundial Growers stock hasn’t plummeted because the market isn’t paying attention. But the recent pullback from a sector-fueled rally does look at least intriguing. I’d certainly rather own SNDL than Aurora Cannabis (NYSE:ACB), another high-reward, high-risk play. And outside of majors like Canopy Growth (NYSE:CGC) and Cronos (NASDAQ:CRON), at this point any cannabis play is going to have some balance sheet and profitability risks.
SNDL definitely has those risks — but intriguing potential rewards as well.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
