Few, if any, industries have been hotter in recent months than cannabis. With Canada having waved the green flag on recreational pot in October 2018 and 36 states having legalized marijuana to some degree in the U.S., the North American cannabis industry looks ripe to deliver incredible growth throughout the 2020s.
We've also been witnessing a clear separation between the haves and have-nots in the cannabis space. U.S. multistate operators are among the haves, skyrocketing as they head toward recurring profitability in the largest marijuana market in the world by annual sales.
But among this veritable sea of opportunity, investors have latched onto a small Canadian licensed producer as their favorite play.
Sundial Growers is suddenly the most popular pot stock
Through this past weekend, marijuana penny stock Sundial Growers (SNDL -1.26%) was higher by nearly 550% over the trailing three-month period. On investing app Robinhood, which is known for attracting young and novice investors, Sundial had clawed its way to the No. 8 spot on the platform's leaderboard -- ahead of established winners like Amazon, Walt Disney, and Microsoft.
If you're wondering why Sundial has been so unstoppable of late, the answer appears to lie with three catalysts.
To begin with, investors are clearly excited about Democrats being in control in Washington. In Gallup's annual survey of cannabis sentiment, a record 68% of respondents favored legalization in 2020. More importantly, 83% of self-identified Democrats were in favor of legalizing cannabis, compared to just 48% of Republicans. With Sen. Mitch McConnell no longer able to block legislation from reaching the Senate floor for a vote, the possibility of federal change is greater than it's ever been. Legalizing weed at the federal level would allow Sundial and its Canadian peers to enter the considerably more lucrative U.S. market.
Secondly, Sundial Growers is one of around a dozen stocks that's been swept up in the recent Reddit rally frenzy. Retail investors in the WallStreetBets chatroom on Reddit have essentially banded together to buy shares and out-of-the-money call options on stocks with high levels of short interest. Sundial doesn't have a high level of short interest. It is, however, a penny stock -- and low-priced stocks have always fascinated young retail investors.
Third, Sundial's management team has worked hard over the past couple of months to repay debt and improve the company's cash position. A relatively clean balance sheet could come in handy if Sundial Growers gets the green light to enter the U.S. market.
The 209% gain that should terrify Sundial shareholders
Unfortunately for shareholders, this final catalyst is a big reason why Sundial Growers is one of the most dangerous marijuana stocks.
To pay down debt and build the company's cash position to approximately $610 million (as of this past weekend), Sundial has been selling its stock and converting debt to equity at an alarming pace. This might sound relatively harmless, but it has the potential to severely dilute existing shareholders over time.
As an example, Sundial Growers ended September 2020 with approximately 509 million outstanding shares. Four months later, following multiple rounds of share issuances and debt-to-equity conversions, Sundial is sitting on (drum roll)... 1.56 billion outstanding shares. In four months, Sundial's outstanding share total has increased by 209%. That's insanely high, and it demonstrates a complete disregard on management's part for improving shareholder value.
What makes this situation even worse is that Sundial's operating performance has been poor. The company is transitioning from a wholesale-focused business model to one that caters to the retail side of the cannabis industry. While this move makes sense for Sundial -- especially with retail margins handily outpacing wholesale cannabis margins -- it's going to take time before this transition pays off. In the September-ended quarter, Sundial's year-over-year sales were more than halved, with the company logging a charge-laden operating loss of $71.4 million Canadian.
Yet, with 1.56 billion shares outstanding, this backpedaling operating model is now worth a staggering $1.76 billion.
Dump Sundial for this Canadian marijuana stock
My suggestion to the cannabis investment community is simple: Dump this zero and find yourself a Canadian pot stock hero, like OrganiGram Holdings (OGI 2.83%).
OrganiGram is a New Brunswick-based producer that's operating only one facility (Moncton). Having a single production and processing site makes it easy for OrganiGram to tweak its output and expenses to match prevailing market conditions. Should future demand merit a full expansion of the Moncton facility, OrganiGram could produce north of 110,000 kilos of weed per year.
The facility is set up to drive efficiency. Cultivation rooms employ three tiers of growing to maximize yield and drive down per-gram production costs. OrganiGram also acquired fully automated equipment capable of producing up to 4 million kilos of chocolate-infused edibles each year. Further, it developed a proprietary powder that can be added to beverages to expedite the time it takes for cannabinoids to take effect. OrganiGram is built to see the retail cannabis market drive its operating margins above the industry average over the long run.
If you need even more evidence that OrganiGram is the better value, how about this: In the current year, Sundial is expected to generate $63.5 million in sales. By comparison, OrganiGram's full-year revenue should top $106 million, with the company having an outside shot at turning the corner to profitability.
OrganiGram's market cap of $542 million is less than a third that of Sundial, but it's a much more well-rounded cannabis company. Do yourself (and your wallet) a favor and don't get lured in by the baseless hype surrounding Sundial Growers.
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.