Turnarounds like the one being undertaken by Sundial Growers (NASDAQ:SNDL) are not simple. They’re usually not all that fast. And though SNDL stock has rallied nicely of late, they are definitely not without risk.
But Sundial at least is making progress. I wrote coming into the year that the stock looked intriguing as the turnaround began to take hold. And so far in 2021, investors have agreed, with SNDL stock gaining a healthy 26%.
I still like the stock here, albeit with a bit more caution. The quick rally does price in more in the way of success. A big recent move looks like it probably won’t quite work out. And I remain far less bullish on U.S. legalization than do the cannabis bulls that have propelled the sector higher since Election Day.
Still, taking the long view, there’s still a good amount to like about Sundial here. Even if the most recent move doesn’t work, Sundial at least has positioned itself to take another swing.
Getting the Balance Sheet Fixed
The first step in a turnaround is getting a company’s financial house in order. Sundial Growers has done that.
As I wrote in December, this was a company that wasn’t guaranteed to even make it through 2020, let alone provide positive shareholder returns. At the end of 2019, Sundial had 178 million CAD in debt, and 45 million CAD in cash.
Meanwhile, the company was burning cash in its operations as the Canadian legalized market executed its bumpy rollout. With the plunge in cannabis stocks, and overcapacity across the industry, lenders were tightening up. There was a scenario in which Sundial wound up entering a restructuring in relatively short order.
But Sundial swapped stock for debt and sold its U.K. business. As a result, Sundial now is not only debt-free but reported 21 million CAD in cash in their latest quarter.
To be sure, it’s been a painful process for shareholders, who have been diluted significantly. Sundial had 107.2 million shares outstanding at the end of 2019. The figure now is 1.1 billion. That’s up there with Aurora Cannabis (NYSE:ACB), which at least used its stock for (admittedly ill-fated) acquisitions.
Still, dilution is better than what the alternative could have been. And now, Sundial is ready to take the next step.
The Zenabis Deal
Sundial tried to do so on Dec. 30 with a creative — and maybe even tricky — step.
The company used a little over half its cash to buy a so-called special purpose vehicle. That vehicle owned 58.9 million CAD of secured debt in smaller Canadian cannabis company Zenabis (OTCMKTS:ZBISF).
By purchasing the debt, Sundial seemed to put itself in a no-lose situation. The Zenabis debt carries a whopping 14% interest rate — plus a royalty on the company’s quarterly revenue.
If Zenabis paid the debt in full (over eight years), Sundial would do quite well with its cash. If it didn’t, the secured nature of the debt meant Sundial would have claim to Zenabis’ assets at an attractive price. Zenabis has a market capitalization just shy of 90 million CAD.
It would appear Sundial preferred the assets to the cash. On Jan. 6, the company issued a notice of default (which Zenabis disputed).
Unfortunately, Zenabis seems to have found a white knight. It found a lender for 60 million CAD to refinance the Sundial debt. Sundial should make a couple million on the deal, but its hopes for picking up Zenabis’s assets on the cheap appear dim.
The Case For, and Against, SNDL Stock
It’s difficult to tell how much the Zenabis deal moved SNDL stock. Cannabis stocks on the whole rallied again in early January when Democratic candidates won both Senate seats in Georgia. SNDL has slipped since Zenabis announced its intention to refinance, but given the volatility in a stock like SNDL (and indeed the cannabis sector as a whole) the two may not be directly correlated.
Still, at the very least the effort signals two things. First, Sundial’s management is willing to think outside the box to find a way to drive growth. And, second, that management team is confident enough in the trajectory of the business to make a move that would have tied up half of existing cash for eight years.
Both look like good news. So, what goes wrong?
A lot. Again, Sundial isn’t profitable, or even all that close yet. The rally in the cannabis sector from here looks a bit questionable, given that it seems tied to election results. (A broader rally in small-cap stocks likely is a factor as well.)
A 50/50 Senate is simply not enough to push federal legalization through, and it’s federal legalization that’s required for Canadian operators like Sundial to enter the American market. Even once that market does open, the fortress balance sheets of Canopy Growth (NASDAQ:CGC) and Cronos (NASDAQ:CRON), in particular, look like enormous competitive advantages.
Therefore, at this point, I’d be hoping for the pullback of the last few sessions to continue. But cannabis bulls admittedly can and likely do see the sector differently. Those bulls should take a long look at SNDL stock.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.
