Though all eyes are on tech and other innovative industries, it's marijuana that could be one of the fastest-growing industries of the decade.
According to New Frontier Data, cannabis sales in the U.S. are expected to grow by 21% annually between 2019 and 2025, ultimately reaching $41.5 billion by mid-decade. Meanwhile BDSA recently estimated that Canadian pot sales would rocket from $2.6 billion in 2020 to $6.4 billion by 2026. In short, it's a great time to be a marijuana industry optimist.
Investors are obsessed with a marijuana penny stock
But of the dozens of marijuana stocks investors could choose to buy, it's Canadian licensed producer and penny stock Sundial Growers (SNDL 2.04%) that's become the clear-cut favorite. On millennial-dominant online investing app Robinhood, Sundial is the fourth most-held stock, which puts it ahead of the likes of Amazon, Microsoft, and Walt Disney.
Part of the reason Sundial has been so popular is its association to the retail investor-fueled Reddit frenzy. Beginning in January, retail investors on Reddit's WallStreetBets chatroom began buying shares and out-of-the-money call options in dozens of stocks with high levels of short interest, with the goal of effecting a short squeeze. GameStop is the best-known of the Reddit plays, but Sundial Growers was also quite popular for a few weeks.
Investors appear to be taken by the prospects of the U.S. legalizing cannabis at the federal level, too. Joe Biden's victory in November, coupled with the Democrats winning back the Senate by the slimmest of majorities in early January, may pave the way for real marijuana reform in Washington. Keep in mind that an all-time record 68% of Americans favored legalization in Gallup's most recent national poll, and self-identified Democrats have a considerably more favorable view of pot than folks identifying as Republicans.
The third lure for Sundial looks to be its monstrous cash pile. Following a $74.5 million registered direct offering in early February, the company announced that it had $610 million in unrestricted cash on its balance sheet. An additional $89 million worth of warrants were exercised just weeks later. This effectively gives Sundial in the neighborhood of $700 million in cash to go shopping or work its way into the U.S., if marijuana's scheduling is changed.
This will be the most important number in Sundial's forthcoming earnings report
But this week marks a big test for the most-popular pot stock. On Wednesday, March 17, the company will be lifting the hood on its fourth quarter and full-year operating results. A lot of investors will be (logically) honing in on Sundial's retail sales or paying close attention to its bottom line to see if its recent quarterly losses are shrinking. However, neither of these figures is the most important number.
Following countless registered offerings, at-the-market capital raises, and debt-to-equity swaps, the most important number is Sundial's outstanding share count. We know from its Feb. 4 update that the company had approximately 1.56 billion shares outstanding. This figure is probably more like 1.66 billion after the exercising of 98.3 million warrants last month.
What's more, Sundial Growers' board OK'd a shelf offering that would allow it to sell a mixed basket of securities to raise up to $1 billion over time. Put another way, its board OK'd the company to sell up to $1 billion more in common stock. This comes after a more than 1.1 billion increase in its outstanding share count since the end of September.
Even if Sundial's report doesn't reflect some of the latest capital-raising activity, the substantial increase in the company's outstanding share count through the end of 2020 will be impossible to hide. It'll force investors to confront the reality that Sundial's highly touted cash pile was built atop the backs of its trusted shareholders.
Investors are about to realize that Sundial is grossly overvalued
Sundial's full-year results and 2021 outlook might also decisively demonstrate just how expensive it is, relative to other Canadian licensed producers and U.S. multistate operators.
In partial defense to Sundial, the company is in the midst of an operating transition. Having previously focused on wholesale cannabis, Sundial is making the shift to the retail side of the equation, which offers much juicier margins. Undertaking this transition means forgoing wholesale cannabis revenue and building its retail segment from the ground up. In other words, year-over-year revenue comparisons are ugly, with a capital 'U.'
But even giving Sundial the benefit of the doubt with this business transition, its projected forward-year price-to-sales ratio is in nosebleed territory. Because it has an estimated 1.66 billion shares outstanding, the company's market cap is $2.36 billion (even with a minuscule share price of $1.42). Yet Wall Street's current consensus is only for $89 million in full-year sales in 2022. That's a price-to-sales multiple of nearly 27 for next year. By comparison, most U.S. multistate operators can be purchased at multiples of 2 to 5 times sales in 2022.
Wall Street also isn't expecting Sundial to make a run of recurring profits until 2022, at the earliest. With ongoing share-based dilution and its existing 1.66 billion outstanding shares, the company will be lucky to generate a few pennies per share in annual profit.
Even looking three or four years into the future, I can't even come close to justifying its current valuation. My suspicion is investors will also come to this conclusion after the company releases its Q4 earnings report and offers guidance for 2021.