It’s up for debate what, exactly, has driven the big gains in Sundial Growers (NASDAQ:SNDL) stock so far in 2021. SNDL stock has tripled year-to-date (YTD) — even though it sits 60% below last month’s highs.
Those highs were brief, admittedly. They appear part of the same wave of buying driven by Reddit’s r/WallStreetBets and other traders. The move to nearly $4 — from a Dec. 31, 2020 close of just 47 cents — could have been catalyzed by those traders creating a short squeeze. A so-called “gamma squeeze,” driven by market makers’ hedging of call options, is another possibility.
More simply, traders piled into the stock. That buying alone can cause big moves, irrespective of how many shares are sold short or how many call options are owned.
However, the problem is that pretty much all of those drivers — all of which contributed to some degree — are temporary. Over time, SNDL stock is going to settle toward something that approximates fair value. The stock had already done so before being boosted recently. Now fourth-quarter earnings, due Wednesday, could prove to be a reality check for the big YTD rally.
The Case for SNDL Stock — At the Right Price
To be fair, I don’t think it’s necessarily ridiculous that SNDL stock has rallied so far this year.
As a group, cannabis stocks have done well. The ETFMG Alternative Harvest ETF (NYSEARCA:MJ) has gained 75% so far this year. So, it’s not necessarily a surprise that smaller, high risk-reward SNDL has outperformed the sector.
Meanwhile, Sundial has taken advantage of the rally. For example, it sold stock to raise capital, including offerings of $100 million and $74.5 million last month. Warrant exercises also added another $89 million in cash.
Underpinning the 2021 optimism is an intriguing turnaround case. As I detailed in December, Sundial has fixed its balance sheet and better positioned itself going forward. Plus, the Canadian market as a whole is recovering from the novel coronavirus pandemic. And Sundial is focusing on higher-end inhalable products, including a recent launch of concentrates.
So, there’s good news here. Again, I recommended the stock just three months ago. This isn’t some crazy shell company being pumped by traders. But that doesn’t mean that SNDL stock is a buy right now — and it doesn’t mean that earnings this week aren’t dangerous.
Why Earnings Look Dangerous
In fact, earnings seem like a significant near-term risk, for two core reasons.
The first reason is that it’s still early in the turnaround. Sundial probably isn’t ready to accelerate growth. For example, revenue fell sharply on a sequential basis in the third quarter. It will take time to reverse that trend.
And even with a lower price and a lower share count, investors did not react well to that report. SNDL stock fell over 40% in five trading sessions. To be fair, that decline was exaggerated by a huge rally going into the report.
However, this release seems awfully familiar. The spike into earnings this time around isn’t quite as steep, but it’s still significant. SNDL stock has gained 42% in the past seven days. It’s more than doubled from where it traded before the first Reddit wave hit in late January.
Meanwhile, reports elsewhere in the sector haven’t sparked much optimism. Aurora Cannabis (NYSE:ACB) saw its highs undercut by earnings last month and only recently put in a bottom. Today, it’s still off 69% from its recent high of $18.98. Likewise, Canopy Growth (NASDAQ:CGC) and Tilray (NASDAQ:TLRY) reported around the same time and their charts look similar to that of Aurora.
Reddit aside, it certainly looks as if optimism toward potential U.S. federal legalization drove cannabis stocks higher. But the reality of the still-difficult and still-unprofitable Canadian market sent them lower. Now, it seems unlikely that Sundial is quite ready to buck that trend.
An Opportunity on the Dip?
Longer-term, a correction here actually would be healthy. This is a stock that simply needs a lower price.
Because, again, there’s a case here. Sundial has cash. Plus, the merger of Aphria (NASDAQ:APHA) and Tilray could be the start of broader consolidation and cost-cutting in the industry. Sundial could be a buyer — or a target.
But this is also a company that now has a fully diluted market capitalization well past $2 billion. According to Seeking Alpha, trailing twelve-month revenue is just $55 million. Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) remains sharply negative.
This is a company with a lot of work left to do and a lot of risk still to manage. An over 200% rally in two and a half months doesn’t price that in. So, as has been the case for other cannabis stocks, the upcoming earnings could give SNDL stock a much-needed reality check — and potentially a much better entry point.
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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.
