2023-11-17 06:30:26 ET
Summary
- SNDL Inc. has made enormous strides in improving their financials.
- Yet, they are still saddled with negative margins and returns while only growing revenue by 4.79% over the last year.
- I consider their franchise-oriented business model inferior to non-franchise business models.
- With an EV/EBITDA of 14.76x, I view the company as currently significantly overvalued.
- I currently rate SNDL as a Hold.
Thesis
I have been studying the cannabis industry since early 2021. At the time, the entire industry had rallied and was extremely overvalued. Most of the industry was cash burning and took the opportunity to raise money through offerings. In the time since then, I have watched a majority of the industry burn through the cash reserves.
SNDL is attempting to build an empire out of everyone else's broken toys and have a history of purchasing cash burning assets. While I used to be extremely bearish on the long term viability of their business model, they have managed to improve the financials of many of the assets they have taken control of. This has allowed SNDL to diminished their annual cash burn rate since my last article . After looking over their current financials and valuation, I presently rate SNDL as a Hold.
Company Background
SNDL is currently the second largest cannabis company in Canada by revenue. They operate through four segments: Liquor Retail, Cannabis Retail, Cannabis Operations, and Investments. They were originally formed in 2006 under the name Sundial Growers Inc. and are headquartered in Calgary, Canada.
SNDL Segments (Q3 2023 Investor Presentation Page 5)
Relevant History
I covered this more in my last article about SNDL Inc. ( SNDL ), but they stood out to me because they were able to raise a total of $1.18B through dilutive offerings. Then while the entire industry was overvalued, I watched them begin buying assets and handing out loans to distressed competitors.
- February of 2021 , they invested $22M in a joint venture with Indiva Limited.
- May of 2021, they acquired Inner Spirit Holdings Ltd. for $131M .
- March of 2022 , they bought Alcanna , a chain of liquor stores.
- June of 2022 , they made a $100M investment in Zenabis Global Inc.
- August of 2022 , they purchased The Valens Company.
- August of 2022 , they bought Superette.
- December of 2022 , they entered into a franchise agreement with Nova Cannabis.
Long-Term Trends
The Canadian cannabis market is projected to have a CAGR of 15.4% through 2028. The Canadian liquor market is expected to have a CAGR of 4.78% until 2028.
The United States is in the middle of the process of rescheduling cannabis to level 3. Once the process is finalized , this will open up a new market for all of the Canadian cannabis companies, including SNDL.
Guidance
Their most recent earnings call transcript revealed that this most recent quarter represents a significant financial milestone for SNDL. For the first time ever, they have achieved both positive net cash from operating activities and positive free cash flow.
SNDL Guidance 1 (Q3 2023 Earnings Call Transcript)
Their Q3 2023 investor presentation broke down their segment results visually. I should clarify that all the values in the guidance section are expressed in Canadian dollars. When comparing these values to their previous quarter , the liquor segment remained fairly stable while producing an Adjusted EBITDA of $19.2M.
SNDL Liquor Segment (Q3 2023 Investor Presentation)
Their cannabis retail segment rose from $71.9M to $75.5M produced an Adjusted EBITDA of $8M.
SNDL Cannabis Retail Segment (Q3 2023 Investor Presentation)
Their cannabis growing segment rose from $20.9M to $21M and produced an Adjusted EBITDA of -$4M CAD.
SNDL Cannabis Growing Segment (Q3 2023 Investor Presentation)
Their investment segment grew in size, but experienced a drop in revenue.
SNDL Investment Segment (Q3 2023 Investor Presentation)
Forward looking statements indicate they are developing a private label for wine, and plan to launch it in the first quarter of 2024.
SNDL Guidance 2 (Q3 2023 Earnings Call Transcript)
They announced an extension of their buyback program.
SNDL Guidance 3 (Q3 2023 Earnings Call Transcript)
Other than them expecting a margin expansion for their liquor segment, they are not yet giving guidance for 2024.
SNDL Guidance 4 (Q3 2023 Earnings Call Transcript)
Quarterly Financials
Their quarterly financials are showing some seasonality. They typically experience lower revenue every Q1. This is not unusual for Canadian companies; depending on the products and services they provide, most are affected by the changes in buying habits that occur as a result of winter. I should note that they experienced a dramatic revenue increase in Q2 2022 when they purchased their liquor segment. Also, all dollar values here in the financials section are in USD and not CAD.
Eight quarters ago SNDL had a quarterly revenue of $11.3M. Four quarters ago that had risen to $166.9M. By this most recent quarter that had risen further to $174.9M. They have grown revenue by only 4.79% over the last year.
SNDL Quarterly Revenue (By Author)
Their margins have improved significantly and are nowhere near as terrifying as they were in 2021. As of the most recent quarter gross margins were 20.47%, EBITDA margins were -3.09%, operating margins were -10.06%, and net margins were at -9.15%.
SNDL Quarterly Margins (By Author)
The sum of their last eight quarters of dilution comes to 29.86%; over the last four quarters this has dropped slightly to 14.60%. Their highly advertised buyback program has yet to overcome their pace of dilution.
SNDL Quarterly Share Count vs. Cash vs. Income (By Author)
They do not carry any long-term debt. This most recent quarter, SNDL had $1M in net interest expense, total debt was at $125.9M, and long-term debt was at $0M.
SNDL Quarterly Debt (By Author)
As of the most recent earnings report, cash and equivalents were $149M, quarterly operating income was -$18M, EBITDA was -$5.4M, net income was -$16M, unlevered free cash flow was $22.9M, and levered free cash flow was $21.9M.
SNDL Quarterly Cash Flow (By Author)
Total equity has been dropping since its increase in Q1 2022. other than the temporary dip in Q1 2023, this decline has been fairly steady.
SNDL Quarterly Equity (By Author)
Although they have been improving, their returns are still negative. As of the most recent earnings report ROIC was -1.46%, ROCE was -1.72%, and ROE was -1.64%.
SNDL Quarterly Returns (By Author)
Valuation
As of November 16th, 2023, SNDL had a market capitalization of $372.46M and traded for $1.53 per share. They do not pay a dividend, and do not have positive net income, so they have no forward P/E for me to use to calculate a PEGY estimate.
SNDL currently has an EV/EBITDA of 14.76x, a Price/Sales of 0.60x, and a Price/Book of 0.41x. Considering the fact that they do not have positive net income, and only grew revenue by 4.79% over the last year, I view their EV/EBITDA of 14.76x as showing the company as currently significantly overvalued.
SNDL Valuation (Seeking Alpha)
Catalysts
The entire industry faces a major catalyst. On October 6th, 2022, Biden set in motion the rescheduling process. When the United States reschedules, I expect that the entire industry will rally.
With most of the Canadian sector still in a consolidation phase, it is possible that the pace of bankruptcies may increase enough that some of their competitive risk goes away. If competition is lowered by enough, it may even allow for the price of wholesale cannabis to rise. This could diminish oversupply and improve profitability .
Risks
SNDL exists in a highly competitive environment. As the price of wholesale cannabis stays depressed, producers are likely to continue to be driven out of business. For as long as the present situation continues, Canada's cannabis producers will suffer.
Although unlikely, the wholesale price of Canadian cannabis may fall even further. If this happens, SNDL's production segment will find themselves with deteriorating margins.
Red Flags
When I first began studying the cannabis sector, SNDL was intriguing because they appeared to be setting themselves up to become a dominant player. However, when I began reading through their earnings call transcripts, I was alarmed to see several red flags and decided I would have to abstain from investing into SNDL. Mostly, the problem is that they present information to investors in a way which leaves open the opportunity for many new investors to walk away with an incorrect understanding of their financial situation.
Their gross, operating, and net margins are always expressed in dollar values instead of percentages.
Flag 1 (Q1 2021 Earnings Call Transcript)
For the entire year after the Alcanna purchase, revenue growth was compared to the correlating quarter in the previous year, while comparisons to the previous quarter were de-emphasized or avoided entirely. This obfuscated the fact that topline revenue fell from $173.8M USD in Q2 of 2022, to $149.8M USD in Q1 of 2023.
Flag 2 (Q3 2022 Earnings Call Transcript) Flag 3 (Q4 2022 Earnings Call Transcripts) Flag 4 (Q1 2023 Earnings Call Transcript)
They continue to loudly advertise their buyback program, yet never mention in the earnings calls that the combined effects of stock-based compensation and other dilution has been out pacing it.
SNDL Total Common Shares Outstanding (Seeking Alpha)
The company regularly advertises that their portfolio of cannabis-related investments is worth several hundred million dollars. Yet fail to bring up the risk that comes with loaning out money to financially distressed competitors. As a result, a significant portion of their write downs are as a result of their investments producing a steady stream of losses from unusual items.
SNDL Unusual Items (Seeking Alpha)
While it is true they are affected by annual seasonality every Q4, I believe it paints an incomplete picture of the situation to refer to the annual Q1 restock costs as an 'inventory impairment'. The cannabis they have to destroy as a result of reaching expiration and the cost of restocking their liquor stores should both be considered a normal part of operations and should fall into either Cost Of Goods Sold or Cost Of Revenue.
Flag 5 (Q1 2023 Earnings Call Transcript)
Conclusions
Overall, SNDL has made enormous strides in improving their financials. However, they are still saddled with negative margins and returns while only growing revenue by 4.79% over the last year. They currently face significant risk from having to absorb additional cash burning assets as some of the companies they loaned money to may still fail. If they weren't currently facing a massive catalyst from the U.S. rescheduling, I would still be giving them a Sell rating.
As the situation sits right now, I consider their franchise oriented business model inferior to non-franchise business models. So I would need for them to achieve significant improvements in their returns before I would ever consider buying.
For further details see:
SNDL: Improving Financials But Still Not Enough For Me To Buy (Rating Upgrade)