On the surface, the case for Sundial Growers (NASDAQ:SNDL) stock isn’t outlandish. It’s the price that’s the problem.

The somewhat niche cannabis producer saw its stock get caught up in the Reddit-driven frenzy of late January. SNDL stock has pulled back since, but much of the gains remain. Shares closed at 60 cents on Jan. 27, and though they briefly neared $4 two weeks later, they’ve still rallied 130% in a little over a month.

That rally still seems like too much, even for a company that admittedly offers some promise. There’s a price at which SNDL stock is attractive, but I don’t believe $1.38 is it.

Getting the House In Order

At the very least, Sundial Growers is in far better shape than it was just 14 months ago.

At the end of 2019, Sundial had 178 million CAD in debt. By Feb. 29 of last year, cash was down to just 43.1 million CAD. Sundial had breached the covenants on its credit agreement as well.

Between the covenant breaches and negative free cash flow, bankruptcy was a real possibility. The plunging SNDL stock price — which bottomed at 14 cents last year — didn’t help the cause.

But Sundial found a way. It exchanged stock for debt. It sold its U.K. business. Now the balance sheet is in pristine shape. After more stock sales earlier this year, as of last month, Sundial had cash of 610 million CAD.

So bankruptcy is off the table for some time to come. Indeed, Sundial now has the resources to aggressively attack its markets in a way that it couldn’t as recently as last year.

That plan includes a number of brands ranging from value (Grasslands) to premium (Top Leaf). Sundial is focusing on inhaled products, which includes not only dried flowers but derivatives and concentrates.

So Sundial has a chance in an industry toward which I remain hugely bullish.

Massive Dilution

But there are concerns as well. One major concern is the cost Sundial shareholders have paid to fix up the balance sheet.

That cost has come in the form of dilution. At the end of 2019, Sundial Growers had 107 million shares outstanding. As of early February, the share count had reached 1.56 billion.

Put another way, the same number of shares now reflect an ownership stake that is less than one-fourteenth what it was fourteen months ago. And so even though the SNDL stock price has fallen, the valuation applied to this company is massively higher.

Using the year-end 2019 share count of 107 million, and the Dec. 31, 2019 closing price of $3.01, Sundial had a market cap of about $322 million. Adding debt net of cash (converted into U.S. dollars), the enterprise value was a little over $400 million.

Even with SNDL stock down by more than half since the end of 2019, the business has a far higher valuation. In fact, it has more than quadrupled, to about $1.7 billion.

What’s Priced Into SNDL Stock?

That’s a big figure in the context of Sundial’s performance.

We’ll get fourth quarter earnings later this month, but through the first three quarters of 2020 Sundial generated 47 million CAD in net revenue. Full-year figures thus look likely to be around 65 million CAD at most — or a little over $50 million.

Again, I’m a big-time, long-running cannabis bull. I think the industry has not just years, but decades of growth ahead. And Sundial has at least positioned itself to be a part of that growth.

But we’re also looking at a stock that now trades at about 34x revenue. Even on an Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) basis in Q3, Sundial’s loss totaled about one-third of revenue.

To be sure, both the multiple and the losses reflect the fact that Canadian cannabis still is in the early stages of its growth. Sundial’s results will improve.

And with the balance sheet strengthened, Sundial can try to grow inorganically. It already tried to acquire a smaller cannabis company by buying its debt, only for a refinancing to thwart that strategy.

Sundial even could be a target itself, as we may see a period of consolidation across the industry.

So there’s potential here. But there’s also a 130% rally on little news. There’s a price-to-revenue multiple that’s among the highest in the sector. And there are still-significant ongoing losses.

All told, there’s a lot of work left to do. After the Reddit rally, SNDL stock no longer seems to pricing in that fact.

On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.

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