Canadian pot producer Tilray Brands (TLRY -4.79%) reports its third-quarter earnings on Wednesday before the bell. The stock has been red hot and investors may be tempted to jump on the bandwagon.
But there are serious question marks surrounding the business that investors should consider before buying the stock. Below, there are three things to look at when the earnings report comes out, which could signal whether the business is moving in the right direction and if more acquisitions are on the horizon.
Gross profit and price compressions
A big problem in the industry is that there's considerable competition. A couple of quarters ago, Tilray CEO Irwin Simon referred to small producers as "ankle biters" who were taking market share away from the business. And although the company is trying to grow its market share, it's also trying not to be too aggressive on price. On the company's most recent earnings call in January, management noted that, in the Canadian market, Tilray reduced its prices by only 1.7%, while the market has dropped prices by 22.6%. However, the company's efforts to protect its margins could be tested again amid inflation and consumers potentially being even more price conscious than before.
Despite efforts to protect its margins, Tilray's gross profit was still down in its last quarter. For the period ending Nov. 30, 2021, gross profit of $32.8 million was less than the $35.3 million the company reported in the prior-year period. That's despite net revenue rising by 20% to $155.2 million.
This is an area investors will want to focus on because worsening gross margins will make it more difficult for the company to cover its operating costs and continue its streak of positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). In Q2, its adjusted EBITDA profit of $13.8 million marked the 11th straight period in which Tilray Brands was in the black (on an adjusted EBITDA basis).
Cannabis revenue and market share
What happens with respect to margins and pricing will inevitably have an impact on cannabis-related revenue. Last quarter, while other segments of its business (e.g., distribution, wellness) showed stability, Tilray's actual cannabis revenue declined from $70.4 million in Q1 to $58.8 million in Q2.
The company's retail market share fell to 12.8% (previously it was at 16%), and that's nowhere near its goal of hitting 30% market share in Canada, which is a key part of Tilray hitting its $4 billion annual revenue target by 2024.
If it fails to grow its market share significantly, investors should expect more mergers and acquisitions to help bolster sales. Most recently, last month, the cannabis company announced a strategic alliance with rival Hexo by which it was acquiring $211 million of its senior convertible notes. Under the terms, Tilray could potentially own more than one-third of Hexo's common shares if it chose to convert the notes.
While acquisitions can certainly help grow revenue, for investors it can also mean more cash burn and potential dilution.
Operating expense reductions
The one thing Tilray can do to protect its bottom line regardless of what happens with sales and gross profit is to minimize its operating costs. In Q2, it reported that cost synergies from the deal with Aphria (it closed in May 2021) generated nearly $36 million in cash savings up until that point. The company anticipates more synergies and says it is ahead of schedule of hitting its target of $80 million.
It will be a challenge for Tilray to keep costs down, especially if it pursues more acquisitions. In Q2, selling, marketing, and general and administrative expenses totaled $50 million -- more than the company's gross profit of $32.8 million. The company needs both an improvement in gross profit and some further reductions in operating expenses to at least give Tilray a chance at posting an operating profit (last quarter, the loss was $54.7 million).
Should you buy Tilray stock?
In the past month, shares of Tilray Brands skyrocketed 38%, while the S&P 500 has risen by 4%. The reason behind that optimism, however, is likely more to do with hopes surrounding changes in U.S. federal marijuana laws than based on Tilray's underlying business. Despite the recent wave of bullishness, investors should proceed with caution here and take a wait-and-see approach as there are many question marks surrounding its business that make Tilray too risky of a buy right now. And even if the company performs well in Q3, it's unlikely that it will put all of the concerns noted here to rest.