When you're looking for a cannabis stock to invest in, does it pay to go for the bigger players that are both deep and broad in their markets, or to stick with the smaller upstarts that are more likely to grow rapidly? There's an argument in favor of both approaches, and that's exactly what I'll be discussing today by comparing and contrasting Sundial Growers (SNDL -5.84%) and Tilray (TLRY -8.62%).
But first, let's set some expectations. Neither company is profitable, and neither seems to be growing very quickly at all. And both stocks have fallen over the past three months. Still, I'm of the opinion that there's a clear winner in this matchup, so let's investigate.
Will Tilray span the globe?
When Tilray reports its fourth-quarter earnings on July 28, its claims of being the world's largest cannabis company by revenue will be put to the test. After it reported trailing revenue in December 2020 of $874 million Canadian dollars, the question for shareholders is whether its sales can continue to grow as quickly as they did before the pandemic. Even if a competitor's sales outperformance does knock the company out of the top spot, however, it'll still have a much stronger position in Canada than will Sundial, which as of late last year was only a fraction of its size.
And that's not even mentioning Tilray's substantial footprint in the EU. Its medicinal cannabis operation in Germany harvested its first crop on July 7 and passed it off to a local distributor. That means new revenue should start to register over the next quarter. More importantly, its cultivation center in Portugal ensures that it can serve demand in the EU without paying any tariffs, helping to keep costs low.
Of course, the wild card with Tilray is that investors haven't had a chance to see the company's performance since before its merger with Aphria closed in early May. So, if the two businesses haven't started to demonstrate some of the potential cost savings hinted at by management when the transaction was announced, the stock might take a hit.
Sundial's new business model remains unproven
For a small Canadian cannabis grower, Sundial isn't expanding very quickly. Cannabis revenue shrank by 30% in the first quarter compared to the last three months of 2020.
Sundial recently diversified its operations to include something beyond cultivating and selling marijuana (which it wasn't doing profitably anyway), and that's where its potential value is. With its SunStream Bancorp investment fund, the company aims to purchase debt and equity to produce the returns that its marijuana business hasn't been able to muster. On July 7, it increased its cash commitment to the project by CA$350 million for a total outlay of CA$538 million.
That's no surprise, considering its investment income of CA$15.7 million in the first quarter was larger than its cannabis revenue of CA$11.7 million. In sum, it looks like Sundial is pivoting to focus on its investments rather than its marijuana cultivation, which could allow it to grow profitably in a way it couldn't otherwise.
But what will it do with its production and distribution facilities? Ditching them would go a long way toward stemming overhead costs, but it might also scare off investors who wanted to buy shares of a marijuana cultivation company rather than a bank.
Bet on the global operator
Despite its profitability issues, Tilray is the better cannabis stock in my view.
While Sundial's small size and new cannabis investing strategy mean it could grow by quite a bit in the long term, its management has committed to avoiding unprofitable growth strategies, which could ultimately hold it back. After all, if Sundal has enough cash to devote hundreds of millions of dollars to investments, it can afford to grow its operations unprofitably for quite some time, then work out the inefficiencies later. By choosing to grow only if it is profitable to do so, the company is therefore opting for significantly slower (albeit potentially more sustainable) expansion.
In contrast, given that Tilray is a multinational company that's comfortable with spending money to capture market share now and worrying about profitability later, its ability to enter and exploit new markets is dramatically greater than Sundial's. With its cultivation and manufacturing operations spread across three continents, Tilray makes Sundial look puny.
Even if Sundial can successfully turn a profit by investing in other marijuana companies for now, there's no guarantee that it will be able to continue to do so in the future. If cannabis is legalized in the U.S., businesses will have easier access to financing, and they won't need Sundial to help. That's a major risk, and it's looking more and more likely to happen as time goes by. Plus, Sundial probably doesn't have the resources to penetrate the full U.S. market, considering its presence in Canada is largely regional and it has no significant international holdings.
In contrast, Tilray is already building its distribution network in anticipation of legalization in the U.S. via its beer company, SweetWater Brewing, and it has the ability to scale up its output capacity to serve the expected demand. While it's true that the company will need to increase its efficiency and sales numbers significantly in the near future for the stock to return to growth, there's every indication that it'll be able to do so.