The stock prices of companies part of the cannabis space continue to remain volatile in 2021. Canadian stocks listed on the NYSE and other U.S. exchanges have burnt massive investor wealth in the last two years.
Investors were optimistic about the legalization of cannabis north of the border. However, Canadian marijuana producers are now grappling with lower-than-expected demand, a thriving black market, high inventory levels, and widening losses.
Pot investors believe the near-term headwinds to disappear in the upcoming quarters as the world returns to normalcy as well as liberal regulations regarding cannabis consumption in major markets, especially in the developed world.
Massive growth forecast for the marijuana sector
While tech stocks have driven broader markets to record highs in the last few years, the upcoming decade could be the time for pot stocks to shine. In the U.S., over 70% of the states have legalized medical marijuana products while recreational and medical marijuana is legal in 16 states. The Democrats are likely to decriminalize or even legalize cannabis at the federal level in the U.S. which should drive pot stocks to record highs.
A research report from New Frontier Data forecasts cannabis sales in the U.S. to grow at an annual rate of 21% between 2019 and 2025 to reach $41.5 billion by the end of the forecast period. Comparatively, Canada’s pot market is expected to grow from $2.6 billion in 2020 to $6.4 billion in 2026.
There is a good chance for Mexico to legalize marijuana which suggests the North American cannabis market will generate close to $50 billion in annual sales each year by 2025. Does this make unprofitable marijuana producers like Sundial Growers (NASDAQ: SNDL) a good buy right now?
SNDL stock is down 95% from record highs
Shares of Sundial Growers went public in August 2019 and touched a record high of $11.5 that month. Currently, the stock is trading at $0.70 per share which means it has lost 95% in market value in less than two years.
One of the major reasons for Sundial’s underperformance can be attributed to the staggering dilution in shareholder wealth. In order to lower debt, Sundial issued 1.15 billion shares in just five months (between September 2020 and February 2021).
In 2020, the company reported a loss per share of $0.88 per share. Now, Wall Street expects Sundial Growers to narrow its losses to $0.01 per share in 2021 and 2022. While this improvement in the bottom line might seem attractive, investors should note that Sundial has 1.66 billion shares outstanding. So, it will still post a net loss of over $16 million this year compared to sales of $55 million in 2021.
Sundial had a cash balance of $570 million as of March 15, 2021, which it used to eliminate the outstanding debt on its balance sheet. The recent equity capital raise provides Sundial with the flexibility to execute on multiple growth initiatives going forward. However, it also filed a prospectus recently where Sundial stated the company could raise another $800 million in equity capital, suggesting investors might have to brace for another round of dilution.
Based on its current price of $0.70, Sundial might issue 1.1 billion new shares in the near term.
High valuation for Sundial Growers
Sundial Growers is valued at a market cap of $1.17 billion. It indicates the stock is trading at a forward price to sales multiple of 21.2x which is extremely steep. Further, Sundial is losing market share in the Canadian cannabis market. In Q4 of 2020, the company accounted for 2.7% of the Canadian marijuana market compared to a market share of 3.5% in Q4 of 2019. Its net sales were also down 4.2% year over year in 2020 at CA$60.9 million.
In 2020, Sundial harvested 27,927 kg of dried cannabis compared to 34,012 kg of cannabis it harvested in 2019. If we consider the company’s average selling price of $6.01 per gram it suggests Sundial should have reported close to CA$116 million in gross revenue if it managed to sell 100% of its produce.
However, Sundial’s gross revenue was just CA$73.3 million in 2020 which shows the company sold 60% of its harvested produce increasing its inventory levels in the process.
The final takeaway
Sundial Growers seems like a high-risk investment given its falling market share, negative profit margins, and the potential to dilute shareholder wealth in the future.
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