If I told you that the internet is abuzz about an unprofitable marijuana company with sharply shrinking revenue and a stock price of around $1, you'd probably assume that the chatter was about an impending bankruptcy. Nine times out of 10, you'd be right. But not this time.
Until recently, Sundial Growers (SNDL +0.00%) was one of the lesser-known publicly traded cannabis cultivators. Now, after attracting the attention of a swarm of Reddit and Robinhood traders, the company's stock is growing explosively. In fact, its growth was so extreme that Robinhood limited purchases of the stock on January 28 for several days, though the restrictions have since been lifted. In my view, Reddit's fondness for Sundial is a bit overblown. Nonetheless, the company is in a much better position today than it was in the past.
Why some traders love Sundial
As a meme stock (i.e., a stock heavily influenced by people online) and conversation piece, Sundial's appeal isn't necessarily linked to its fundamentals. Instead, Reddit investors cite its low stock price, its popularity among young retail traders, and its presence in a growing market as reasons to buy.
It's important to be a bit critical here, however. While it's true that some young investors like the stock, the fact that its price is low in absolute terms is not a valid reason to buy it. If you can buy a stock with your pocket change, you're typically going to get the value you paid for: not much. The market will price in expectations for growth, so low-cost shares aren't always the deal that they appear to be.
Similarly, demand for cannabis in the U.S. is indeed growing, but the company's position in Canada, the only place where it actually sells products, is the more important story. Sundial holds an estimated 3.3% share of the Canadian market for recreational marijuana. In 2020, its market share seemed to be slowly increasing, starting the stock's rapid run-up that we're still seeing today.
But don't head to the dispensary to buy Sundial's products and celebrate just yet. Competition in Canada is significant, and many (larger and more popular) companies are vying for control. If Sundial is going to become a power player, it's going to take at least a few more years of steady progress. And if it wants to take advantage of growing demand in the U.S., it'll need a strategy to enter the country first.
Image source: Getty Images.
Reddit isn't the only reason Sundial's stock is rising
Even though meme-based retail trading may be responsible for some of Sundial stock's performance, it's important to recognize that the company is actually significantly increasing its financial strength. In late December of last year, it restructured its liabilities to become debt-free, which could support higher valuations.
Then, on Feb. 2, it closed a new registered offering worth approximately $100 million (less underwriting discounts and offering expenses). In other words, management has an influx of cash to drive new growth. That's a huge improvement compared to a year ago, and worth paying attention to.
There's also reason to believe that management will use its new funds more efficiently than it might have before. The company's cash cost to produce a gram of marijuana dropped by a whopping 42% in the third quarter of 2020 compared to the prior three months. And, in the same period, its cash used for operations decreased 69% compared to the prior quarter.
This paves the way for new sales revenue to render free cash flow, though there's still no guarantee of profitability anytime soon. In other words, if the company can start to grow its revenue aggressively, it'll be in good shape. With its fourth-quarter earnings report looming, investors should keep an eye on these metrics to see whether they've improved further -- or whether they've slipped.
Quite a few investors are piling into the stock to ride its crazy intraday price swings. In my view, a better strategy would be to wait for the company to demonstrate consistently increasing revenue over the course of several quarters, then make a purchase for long-term holding. Until then, the main task is to avoid the temptation of meme-driven price movements.
