Canadian-based cannabis company Sundial Growers (SNDL 0.54%) has been busy this year. Since cashing in on its popularity amid the meme hype with multiple offerings in the early part of 2021, it has been sitting on a pile of cash. It has made multiple acquisitions and investments as it continues to transform its business. The latest move came this month when it announced the purchase of retail company Alcanna (LQSIF), which operates 171 liquor stores in Canada (most of which are in Alberta -- Sundial's home province).
This move further diversifies Sundial's existing operations and gives it yet another source of revenue. But will it make Sundial a better investment, or just a more complicated business to invest in?
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Why Sundial thinks it's a good move
Among the reasons that Sundial is excited about this transaction: It will help boost its cash flow. It notes that over the past 12 months, Alcanna has generated free cash flow of 16.4 million Canadian dollars (while Sundial generates negative free cash flow). The liquor operator has also generated CA$690 million in revenue over the past year, reporting CA$89 million in profit on that, for a margin of 13%.
But it's important to note that long-term profitability is questionable. Over the past five years, Alcanna has generated operating margins that were 3% or lower, including two years when it reported an operating loss.
In addition to alcohol, Alcanna will allow Sundial to double down on its position in the cannabis retail business as well. Alcanna's majority-owned (63%) subsidiary, Nova Cannabis, operates 62 pot shops across Canada (in May, Sundial announced the acquisition of cannabis retailer Inner Spirit Holdings, which has over 100 locations). Nova Cannabis isn't profitable and it generates negative free cash flow (CA$13 million over the trailing 12 months).
Overall, Sundial projects that the acquisition of Alcanna will boost its bottom line. The marijuana company expects to add CA$15 million to its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) on an annual basis through this deal, by benefiting from "synergies and other strategic initiatives."
Why investors might not like this deal
The value of the Alcanna acquisition is CA$346 million and it will be funded entirely through shares -- even though Sundial has the capability to likely pay for this acquisition entirely in cash (as of Aug. 9 it reported an unrestricted cash balance of CA$760 million). It's a bit of an odd move that Sundial isn't deciding to use at least some of its cash on this transaction. That's bad for shareholders, because it will lead to more dilution for a company that has already been notorious for diluting its investors.
Sundial Growers is keeping its cash close to its chest. That could be a sign that it wants to keep the resource there in case it needs it for other deals, or it may be anticipating lots of cash needed ahead to fund its two new retail businesses (Alcanna and Inner Spirit).
The biggest reason for investors to be a little wary of this deal is that neither Alcanna nor Nova Cannabis are incredibly profitable businesses. While some efficiencies may be achieved here, it's difficult to say whether this acquisition will make Sundial stronger over the long run.
Is Sundial Growers a better buy?
As a result of the Alcanna acquisition, Sundial has gotten more diverse, by getting into the alcohol business and diversifying outside of just cannabis. The company is no doubt getting a lot bigger through this transaction and possibly more profitable through the synergies it expects to achieve once this deal is complete (the companies expect the transaction will close in December or the first quarter of next year).
However, I would still stop short of investing in Sundial Growers until at least seeing a couple quarters' worth of statements to see how all these businesses are doing and what the overall picture looks like. Sundial is a stock worth watching and keeping an eye on, but it's still too risky to invest in it. And this latest move proves that dilution should still be a significant worry for investors. Cannabis investors are better off buying shares of more proven companies that are safer buys over the long haul.
