2023-10-31 22:36:30 ET
Summary
- SNDL Inc. capitalizes on Canada’s liquor and cannabis retail market, venturing into Cannabis financing via SunStream Bancorp, addressing funding gaps in the industry.
- Strategic alliances with Nova Cannabis and SunStream Bancorp aim to bolster SNDL’s market reach, facilitating market consolidation and financial support in the cannabis sector.
- Vertical integration and a vast cannabis brand portfolio position SNDL for competitive advantage, potentially leading to higher margins with scaling revenues.
- SNDL's SunStream venture, despite initial losses, is poised to become a value driver, especially amid U.S. cannabis market consolidation and favorable regulatory shifts.
- SNDL's valuation with an adjusted beta coefficient suggests it's a "buy" with potential U.S. market upside.
SNDL Inc. ( SNDL ) emerges as a solid player in Canada's liquor and cannabis retail landscape, with a broad-based business model that spans Liquor Retail, Cannabis Retail, Cannabis Operations, and Investments. Through a strategic alliance with SunStream Bancorp Inc., SNDL endeavors to address the prevalent funding inadequacies within the cannabis domain, extending a financial olive branch to both sizable and nascent entities amidst the industry's ongoing consolidation. In my view, this maneuver potentially places SNDL's valuation in an attractive light, potentially tagging it as a reasonable "buy" at the existing price levels. However, it's crucial to note that SNDL navigates through the intricate tapestry of challenges and opportunities within the Canadian and U.S. cannabis markets, where regulatory uncertainties act as a caveat for SNDL.
Business Overview
SNDL Inc. is the largest private-sector liquor and cannabis retailer in Canada and operates across four segments: 1) Liquor Retail, 2) Cannabis Retail, 3) Cannabis Operations, and 4) Investments. It is well-regarded for producing small-batch cannabis using cutting-edge indoor facilities. And, as one of Canada's preeminent private-sector retailers of liquor and cannabis, SNDL Inc. displays an array of products under distinct retail banners, namely Ace Liquor, Wine and Beyond, Liquor Depot, Value Buds, Spiritleaf, and Firesale Cannabis.
Source: SNDL’s Q2 2023 Earnings Slides.
However, another key feature of SNDL is its vertical integration, which could result in significantly higher margins after it reaches a much larger revenue scale. Their adeptness in cost-effective biomass sourcing, superior indoor cultivation techniques, and innovative product development, coupled with their economical manufacturing paradigms, position them favorably in the competitive Canadian cannabis market. In fact, SNDL’s extensive cannabis brand portfolio, featuring names like Top Leaf, Contraband, Citizen Stash, Sundial Cannabis, Palmetto, Bon Jak, Spiritleaf Selects, Versus Cannabis, Value Buds, Vacay, Grasslands, and Superette, further underscores its potential broad market appeal.
Cannabis Financier
Moreover, it’s worth noting that SNDL is also akin to a cannabis financier through its strategic investment framework and SunStream . Essentially, SNDL Inc. allocates capital towards direct and indirect investments and partnerships across the North American cannabis sphere. Still, note that SNDL Inc. and Nova Cannabis Inc. have deferred the closing of their strategic alliance to November 30, 2023, due to an ongoing review by a provincial regulator, despite having obtained other necessary local approvals. But, taking a step back, I believe partnering with Nova Cannabis likely broadens SNDL Inc.'s market reach by tapping into Nova's expanding presence in Canada's cannabis retail sector. This alliance could enhance firms' financial standing and market share through shared resources, joint ventures, and strategic investments. Such partnerships often bring synergies and allow SNDL and Nova to improve efficiency, reduce costs, and spur innovation, leading to better products and higher profit margins.
Source: SNDL’s Q2 2023 Earnings Slides.
But more importantly, SNDL has entered a joint venture with SunStream Bancorp Inc., in collaboration with SAF Group, to bolster investments in the growing global cannabis sector. This venture aims to offer financial services to cannabis businesses, aiding their expansion. SNDL has committed about $520 million, eyeing the lucrative prospects, particularly in the U.S. market. Through this alliance, SNDL seeks a strategic foothold amidst the U.S.’s complex legal framework surrounding cannabis. With SAF Group, SNDL aims to continue channeling investments and delivering financial services in this sector, placing SNDL at the heart of the evolving cannabis legality and acceptance. Concretely, in the U.S., SunStream’s operation employs both secured and hybrid debt instruments, targeting the anticipated consolidation within the U.S. cannabis arena. It strives to bridge the funding gap for large Canadian cannabis producers facing reduced bank credit while cushioning smaller entities against an equity capital crunch.
SNDL’s strategy through SunStream extends a lifeline to struggling businesses and looks to assimilate smaller, premium, or IP-rich entities at attractive valuations. Financially, the JV adheres to the equity method of accounting, registering SNDL's initial investment as an asset at cost, with subsequent profits or losses from SunStream adjusting the asset value. By June 30, 2023, SunStream's investments were valued at $391 million, having allocated around $450 million to seven firms since its inception. Two of these investments were monetized, yielding about US$42 million in capital returns, including the AFC Gamma, Inc. investment monetized post Q2 2023. So, it seems that so far, SunStream has lost money for SNDL. Still, over the long run, it could become a main value driver, especially if regulations allow for its IPO and further capital injections in the sector. If successful, SNDL could benefit through SunStream of the U.S.’s consolidation of several smaller cannabis players and potentially attractive IPO valuations.
Source: SNDL’s Q2 2023 Earnings Slides.
Furthermore, the main benefit of this structure is that with SNDL’s CEO leading SunStream, there's a symbiotic alignment in the strategic and investment decisions between both entities. Although structured as a 50/50 venture , the governance model suggests SNDL’s dominant control, potentially shielding it from direct U.S. regulatory scrutiny while aligning with SunStream's strategic goals.
Canadian and U.S. Challenges in Cannabis
For context, five years after the legalization of cannabis in Canada, the country's cannabis sector has seen a dip , with output falling to $10.8 billion in July from a peak of $11.6 billion in November 2022, as reported by Statistics Canada. Despite this decline, cannabis usage among Canadians has surged, with 27% of individuals aged 16 and above reporting cannabis use in 2022, a substantial increase from around 15% in 2017. The accessibility of cannabis has plateaued, with 3,332 physical stores operational as of Q1 2023, following a significant rise by Q2 2022.
Source: CTV News.
Unfortunately, industry experts point to a growing trend of legal sales yet highlight an oversaturation of players in the market, leading to a lack of overall profitability. This oversaturation drives an industry consolidation characterized by bankruptcies, restructurings, and mergers. The scenario also impacts various cannabis-related stocks and ETFs in Canada and the US. But concretely, it further exemplifies why SNDL’s SunStream could potentially be a genius move. Clearly, the market is still going through consolidation and regulatory fluctuations. I believe this JV is perfectly positioned and capitalized to be the leading entity in the U.S. Cannabis sector.
In particular, the U.S.’s legal landscape for cannabis is more complicated due to the federal-state legal dichotomy. While several states have legalized cannabis for medical or recreational use, it remains a Schedule I controlled substance at the federal level , making it illegal under federal law. The Department of Health and Human Services requested the Drug Enforcement Agency to reevaluate marijuana's classification under the Controlled Substances Act. If reclassified to a Schedule III substance, this could alleviate several restrictions impeding the cannabis sector. Also, legislation, like the MORE Act , aims to decriminalize cannabis at the federal level, but it has not yet passed?.
A Tricky Valuation
To accurately appraise SNDL, it's imperative to initially grasp the projected growth trajectory of the Canadian cannabis market, which is poised to escalate at a CAGR of 15.40% until 2028 . In my view, the growth narrative of SNDL is robust, with forecasts for 2023 illustrating a growth rate that overshadows this sectoral benchmark, embodying a higher-than-average growth narrative for the ensuing years. The model I've crafted harbors a tempered optimism; it envisions a gradual deceleration in SNDL's revenue growth rate, aligning it eventually with the sector’s expected CAGR, which is the terminal value in my analysis. I believe this optimistic stance towards SNDL is reasonable, as the observable stronger-than-average growth underscores an expanding market share. This, in my opinion, suggests that SNDL's value proposition is resonating well with consumers, laying a foundation for consistent revenue growth over a prolonged period.
SNDL's secular tailwinds. (Source: Statista.)
Notably, SNDL Inc. is on a promising trajectory toward profitability, a trend I foresee enduring. In my forecast, I envision a steady ascent in SNDL's EBIT margins over the forthcoming years, stabilizing at 10%. The Canadian cannabis sector is in flux, with provinces tailoring their pricing and margin strategies. A notable example is the recent initiative by the Ontario Cannabis Store to trim its price margins, catalyzing a more competitive legal market. This initiative mirrors a broader industry endeavor, bolstered by insights from EY and the Cannabis Council of Canada, to refine margin structures and expedite product onboarding processes, all in pursuit of augmented profitability.
However, SNDL specializes in retailing cannabis buds via a spectrum of brands across Canada. The company’s commitment to quality, illustrated through its craft-at-scale modular growing and exemplary processing capabilities, resonates with the industry's trajectory. Moreover, the burgeoning competition within the premium flower segments and cannabis 2.0 unveils potential margin expansion vistas within the premium bud retail sector. SNDL, with a diverse brand ensemble including premium labels like Top Leaf and Contraband, alongside value-centric brands like Value Buds and Grasslands, is well-geared to harness the market's potentially expanding margin paradigms. Lastly, SunStream could be a key driver in SNDL’s margin expansion, as it could further benefit it via consolidation synergies in the U.S. over time.
As the cannabis sector matures with widening margins and escalating legal acceptance, it's plausible to project that SNDL could attain a 10% EBIT margin. This projection is grounded on SNDL's competence to vigorously vie in both the premium and value segments of the cannabis market, align its pricing endeavors with prevailing industry trajectories, and potentially carve a niche in the fiercely competitive Canadian cannabis retail domain. The SunStream initiative could significantly bolster SNDL's profitability in Canada. Yet, given the embryonic phase of the cannabis market post-legalization, I believe assuming a 10% EBIT margin is a level-headed premise, aiding in averting the traps of undervaluing or overvaluing SNDL's standing. A glance at SNDL’s historical EBIT margins unveils a trajectory of improvement, notwithstanding the current negative margins, which I infer is coherent with SNDL’s operational expansion phase. Therefore, I envisage a margin augmentation in the ensuing years, underscoring a positive outlook for SNDL's financial health.
Author's elaboration.
This valuation suggests that SNDL is slightly expensive. However, this assessment potentially sidelines the robust revenue prospects of SunStream in the U.S., along with the anticipated valuation enhancement its IPO could impart to SNDL. It's noteworthy that the valuation is markedly impaired by an elevated beta coefficient of 3.52 , emblematic of SNDL's inherent riskiness. However, this high beta might be a statistical outlier born from SNDL's volatile past. A more nuanced perspective would observe the diminishing beta , positing a more representative beta of 2.0 for SNDL. This revised beta, albeit on the higher side, encapsulates regulatory ambiguities and historical volatility. Employing this adjusted beta in the valuation model may provide a more precise depiction of SNDL's true value, in my view. Through this lens, I believe the initially perceived overvaluation may warrant a re-evaluation, offering a more balanced insight into SNDL's intrinsic value.
Author's elaboration.
As you can see, SNDL’s fair value increases notably when a more pragmatic beta coefficient is employed. I infer that this adjustment more accurately reflects SNDL's inherent value despite continuing to discount its forthcoming cash flows at a notable CAPM rate of 14.9%. Moreover, when viewed through a multiples-based lens , it does appear that SNDL is substantially undervalued compared to its peers.
SNDL's valuation multiples look cheap compared to peers. (Source: SNDL’s Q2 2023 Earnings Slides.)
Overall, analyzing SNDL’s overarching business and valuation context, I find its valuation presents an attractive entry point for investors. This view is further reinforced by its encouraging prospects in the Canadian market, coupled with potentially explosive growth in the U.S., should the regulatory environment evolve favorably. In my opinion, these elements collectively render SNDL a "buy" at the existing price levels. The potential upside in the U.S., predicated on favorable regulatory shifts, significantly improves the investment thesis, underscoring a prudent opportunity to capitalize on the current valuation.
Word of Caution
Indeed, SNDL's robust market stance in Canada, its financial undertakings to tap into the U.S. market, and a seemingly attractive valuation portend a positive outlook in the near future. However, some risks could derail SNDL’s growth. A primary concern is the U.S. regulatory ambiguity due to the federal ban on cannabis, restricting SNDL’s direct entry into the market. While SunStream Bancorp endeavors to navigate this through strategic investments, the venture remains unprofitable thus far, hinging on a speculated consolidation in the U.S. cannabis sector. Despite its strategic rationale, the partnership has incurred losses, casting doubt on its long-term viability and the consequent financial impact on SNDL.
Moreover, the delayed collaboration with Nova Cannabis, owing to regional regulatory scrutiny, echoes the regulatory hurdles SNDL encounters even on its Canadian home turf. The Canadian cannabis market, though maturing, has reported a dip in output, and market saturation is triggering industry consolidation, which could negatively impact SNDL’s market share and margins if it fails to adapt. SNDL’s valuation, albeit enticing, is marked with a high beta coefficient, signifying its inherent risk. Additionally, SNDL’s objective to augment margins through vertical integration and entering premium segments will likely face fierce competition and pricing challenges, potentially inhibiting its margin expansion aims. Collectively, these risks could significantly affect SNDL’s financial standing and market position, potentially diminishing the current valuation's allure for investors.
SNDL's recent decline could be a compelling entry point for new investors. (TradingView.)
Conclusion
Overall, SNDL Inc. has demonstrated strategic foresight by extending its reach in the Canadian and U.S. markets amidst the cannabis sector's complex regulatory framework. Noteworthy is the alliance with SunStream Bancorp to spearhead cannabis financing, establishing a model to encourage investments in this nascent industry. Despite initial financial setbacks, this initiative holds potential. Further, my valuation analysis indicates a pathway toward profitability. Initially, the valuation suggests a slight overvaluation; however, a nuanced adjustment of the beta coefficient reveals a more favorable valuation, endorsing a "buy" rating for SNDL. SNDL’s low valuation multiples corroborate this assessment when compared to its peers. So, the anticipated growth in the U.S., contingent upon amenable regulatory changes, bolsters the investment thesis, showcasing a prudent investment opportunity at the current valuation.
For further details see:
SNDL: Promising Cannabis Expansion Via SunStream Bancorp