Sundial Growers (SNDL +9.93%) is a risky pot stock to invest in. The company is transitioning its business from wholesale to branded sales, revenue is falling, losses are deep, and the company just hasn't given investors much of a reason to be bullish on its operations. Since hitting highs of nearly $4 a share earlier this year (largely due to speculative retail investors), Sundial's stock has come crashing down to reality and now trades at around $0.70.
But investors shouldn't lose hope just yet. Although the company's latest quarterly results showed lackluster sales numbers that still pose many questions, there are three positives to take away from the earnings report.
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1. The company is bringing down its number of SKUs
Sundial reported its first-quarter results on May 11, and its gross margin for the period ending March 31 was awful -- negative 3.45 million Canadian dollars. Even when factoring out impairment and fair value adjustments, the company was still in the red, and it blames the poor numbers on "price compression" as well as an increase in operating costs.
That's the bad news, but the good news is the company says it is making changes -- such as cutting down its number of products. Sundial said in its earnings release that it was liquidating some low-margin items and is going to cut back on offering discounted products in markets where the economics don't make sense. The company says that by focusing on premium inhalants, the latter half of fiscal 2021 should start to look much better for the business.
Anytime a business simplifies its operations and focuses on more profitable areas, that's a big positive. Being too aggressive on price and having too many products is a surefire way to destroy any chance at profitability. Getting away from that is a good move for Sundial, and one that should pay off in the near future.
2. It posted an adjusted EBITDA profit
Even though its gross margin was negative, Sundial still managed to report an adjusted EBITDA profit -- the first time it has ever done so. Despite incurring a net loss of CA$134.4 million from continuing operations, much of that (CA$129.9 million) related to fair value changes in derivative warrants. And after adding back inventory obsolescence, transaction costs due to financing activities, and other items, Sundial's adjusted EBITDA was a positive CA$3.3 million -- compared to a loss of CA$5.6 million in the previous quarter.
Adjusted EBITDA isn't a perfect measure of how the business is doing (nor is it even a GAAP number) but for the cannabis industry, it has been a way to gauge profitability and help assess whether a company is at least on the track toward breaking even. I wouldn't go out and buy shares of Sundial because its adjusted EBITDA was positive. But what that positive number does tell me is that profitability isn't all that far away if the company can fix its margins and if the volatility surrounding its warrants and inventory starts to subside.
3. It brought down administrative costs
Another reason to be optimistic on the bottom line is that Sundial has been cutting costs. It reported sales, marketing, and general and administrative (SMG&A) expenses of CA$8 million in Q1, down from CA$8.8 million in the previous quarter. And on a year-over-year basis, the company says SMG&A costs are down by 35%. It's a sizable improvement that will be tested in future periods, especially now that the company intends to acquire Inner Spirit Holdings, a cannabis operator in Canada, which will add to its overhead.
Why I wouldn't invest in Sundial Growers just yet
There were some positives to take away from Sundial's most recent quarterly results. However, there are still many questions that remain, such as what its gross margin will look like in the coming quarters and just how strong its sales will be once its focus is on inhalable products and low prices aren't weighing down its financials. In Q1, Sundial's net revenue of CA$9.9 million was down 29% from the previous period and poses a significant concern for growth-oriented investors.
While I'm optimistic that getting away from low-margin items will help Sundial's business, it still needs to execute these changes and deliver better numbers. In short, Sundial still needs to prove itself to investors. Posting a positive adjusted EBITDA is good, but that alone isn't enough to make the company a "safe" investment.
With the company targeting the back half of the year for when it might start showing stronger results, I would wait at least another quarter or two before seriously considering investing in Sundial -- and only if its numbers improve.
