Cannabis stocks, growth stocks, and all kinds of investments have been volatile this month. The S&P 500 is down nearly 2% since the start of September and the Horizons Marijuana Life Sciences ETF has dropped by 9%. Although some investors may feel the urge to scramble for the exits, the recent sell-off could present some attractive buying opportunities.
One stock investors may be considering is pot producer Sundial Growers (NASDAQ:SNDL). Earlier this year, Reddit investors turned it into a meme stock, creating a buying wave that sent it to a high of nearly $4 a share. This week, its stock fell as low as $0.68 — its lowest level since May 13, when it touched $0.65.
In the wake of that decline, is Sundial Growers a bargain worth buying, or should investors steer clear?
Poor results and potential dilution
Generally speaking, cannabis companies are risky investments since many aren’t profitable and rely on adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to show growth in their bottom lines. Sundial Growers is no exception. The only reason why it may be slightly safer than the average pot stock is that it has a significant amount of cash.
As of Aug. 9, the company reported 760 million Canadian dollars in unrestricted cash. And despite posting losses of CA$322 million over the trailing 12 months, its operating cash burn is only CA$137 million. The company’s balance sheet should keep its operations afloat for the foreseeable future.
However, that doesn’t protect shareholders from seeing their positions diluted. Sundial Growers’ financials are littered with warrants, and in its second-quarter report, there were more than 98 million derivative warrants outstanding at an exercise price of $1.50. Even if Sundial Growers’ stock jumps back above that level, investors holding those warrants could exercise them, which would limit the upside for the stock.
But for speculators, the temptation to take a chance on Sundial Growers may still be there.
Does the potential reward outweigh the risk?
Last year, the market’s interest in Sundial Growers was related to news that it was on the hunt for deals. Management said in its second-quarter 2020 results that it was conducting a “strategic alternatives review.” This hinted at a possible merger, business combination, or an outright sale. And while Sundial Growers has made some modest deals since then, including acquiring cannabis retail company Inner Spirit Holdings, and setting up SunStream Bancorp, a joint venture with private equity firm SAF Group, a blockbuster transaction never materialized.
Sundial itself hasn’t generated consistent revenue growth — indeed, its sales have been declining. And while branching out into the retail cannabis business might help that, such a move could increase its cash burn.
Sundial Growers was a speculative investment then, and it remains one today. The wildcard is that the company still has plenty of cash available should it want to execute a big move without diluting shareholders. But even as the market caps of cannabis companies have been falling this year, Sundial has opted for smaller, more calculated moves. A large transaction doesn’t appear to be what management is looking for.
Its premium is not justified
With its stock trading at more than 21 times revenue, Sundial Growers is valued expensively. Canopy Growth and Aurora Cannabis, two of the largest marijuana producers in Canada, trade at price-to-sales multiples of just 11 and 4, respectively. There’s no good reason to pay such a steep premium for Sundial Growers.
Even if the stock more than doubles in value, investors will need to worry about warrants seriously crimping the stock’s price. They also should remember that when the share price popped in late January, management didn’t issue shares just once but twice.
Sundial Growers’ stock price would have to fall even further before the possible rewards of buying it outweighed the risks. At this point, it doesn’t possess the potential upside that would make it worth gambling on — even for investors with a healthy appetite for risk. Warrants and the threat of dilution will likely hamper its stock price, even if investors turn bullish on the company’s prospects.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.