Why Sundial Growers Is a Gamble in the Cannabis Industry

Sundial Growers (NASDAQ:SNDL) is a Canadian producer and distributor of cannabis products. Like many other Canadian cannabis companies, it stands to benefit massively if marijuana becomes legal across the board in the United States. That would be a huge boon for SNDL stock.

marijuana leaves

Investing in Sundial, however, has more risks than potential benefits. For one, legislation may not be the only major catalyst facing the company. There are other fundamental risks that make it a speculative stock suitable only for investors with a high tolerance for chance.

Here’s why Sundial Growers is a gamble when it comes to the marijuana industry.

SNDL Stock and Industry-Related Risks

Canada is among the few countries that have legalized cannabis for both recreational and medical purposes. In most countries today, cannabis is illegal for recreational purposes but allowed for medicinal use.

In the United States, though, the legal framework is still blurred. Some states and the District of Columbia have fully legalized the medical use of marijuana. But at the federal level, cannabis is on the path to decriminalization yet still largely illegal. That poses some key risks for producers like Sundial Growers.

But marijuana policy was a topic in the U.S. Presidential election and President Joe Biden and Vice President Kamala Harris have promised to help decriminalize the drug. If that happens, it will be great news for the industry.

For instance, SNDL will be able to enter the U.S. market much more easily and target a market share on the recreational side of things. After all, the company’s products are mostly used for recreational purposes, not medical ones. So, SNDL stock’s success — with investors waiting on Sundial to capture market share in the U.S. — depends a lot on legislation surrounding recreational use.

Basically, in a developing cannabis industry, any rules that may differ from Sundial Growers’ expectations could very well harm its business, operations and profitability.

Is a Premium Product Launch Enough to Boost Sales?

In mid January, Sundial announced the launch of “premium concentrates products” from its Top Leaf Brand. This seems like it will be a sales-boosting positive for SNDL stock. In fact, management seems optimistic about the news as well. Andrew Stordeur, President and COO of the company, noted:

“We made a strategic decision to produce these premium products based on demand for solventless, flavorful, pure, and potent cannabis concentrates from a growing group of consumers. […] Our control of the entire manufacturing process from cultivation to extraction enables us to deliver premium quality products on a consistent basis. Adding bubble hash and other advanced concentrates to our product portfolio will expand Sundial’s share of this rapidly expanding market segment.”

That said, the fundamentals behind SNDL stock tell a different story. Simply put, they’re not good at all.

The Major Headwind is Fundamentals

A company can choose to alter its capital structure using debt-to-equity conversions in order to raise capital and reduce debt. In theory, this is good news. But it comes at a significant cost, one too negative for equity shareholders: dilution.

Sundial Growers did that and announced it with its third-quarter 2020 financial results. The company reduced its debt and made its balance sheet stronger, but at the expense of the shareholder with significant equity dilution.

Of course, there was good news in the report. For one, Sundial’s gross margin increased to 20% for the three months ended Sept. 30, 2020, compared to the 14% gross margin for the three months ended Jun. 30. Furthermore, the company eliminated 100 million CAD of debt in 2020 and reduced net debt by 72 million CAD.

But this was the only good news. A closer analysis of the results reveals alarming problems for SNDL stock and a very poor financial performance.

For Q3 2020, some of the worst financial highlights were as follows:

  • Net cannabis revenue fell 36%
  • Cash used from operations decreased 63%
  • Net loss was 71.4 million CAD in the third quarter
  • Adjusted EBITDA loss increased by 13% over the previous quarter to 4.4 million CAD

Another negative operational result was the impairment of property, plant and equipment for 60 million CAD and an inventory impairment of 19.9 million CAD. For a company with a market capitalization of about $876 million, these impairments are pretty significant.

Moreover, Sundial Growers’ net loss in Q2 of 2020, the previous three-month period, was 32.8 million CAD. The company ended its fiscal year 2019 with a negative free cash flow of about 251 million CAD. According to MorningStar, its trailing 12-month free cash flow is a negative 151 million CAD.

In my opinion, an unprofitable company with widened net losses and negative free cash flows represents too risky of a stock. And the recent stock dilution just made valuation worse.

Sundial Could Get Delisted

But that’s not all. In December, Sundial Growers was given a notice that it has a 180-day period until Jun. 26, to comply with the listing requirements of $1 per share. The current stock price is about 80 cents.

The company will regain compliance if, for a minimum of 10 consecutive business, the stock price reaches above that $1 level. If it cannot do that, then the chance of SNDL stock getting delisted is high.

Poor financial performance, stock dilution and the risk of a delisting are too many negatives to ignore. Plus, SNDL’s penny stock status makes it more of a gamble in the cannabis industry than an investment.

All in all, this stock remains a very risky opportunity. From a fundamental analysis, investors are better off if they avoid it.

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

Article printed from InvestorPlace Media, https://investorplace.com/2021/01/why-sndl-stock-is-a-gamble-in-the-cannabis-industry/.

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