I can see why investors might be attracted to Sundial Growers (NASDAQ:SNDL). Sundial Growers stock has a cheap share price: less than 50 cents as I write this. That alone can seem alluring.
Meanwhile, cannabis plays have rallied nicely since November — for good reason. State-level election results look bullish for the industry. We’ve even seen a large merger announced, which raises hopes that smaller companies like Sundial might too prove to be acquisition targets.
Indeed, you won’t find many bigger cannabis bulls than I. That’s why I launched my Cannabis Cash Weekly service. But as bullish as I am on the industry, I still believe that Sundial Growers stock is a trap.
The Industry Problem
To put it bluntly, there are too many cannabis companies in Canada. That alone has been a key reason why the sector has disappointed after huge rallies in late 2018 and early 2019.
Too many companies equals too much production. Too much production leads to lower prices and pressure on profit margins. Yes, Canadian regulators didn’t help, given the amount of red tape that has slowed retail expansion in the country. The novel coronavirus pandemic further affected growth.
But we’re getting past the worst of the pandemic, and starting to return to normalcy. Yet many, and maybe most, Canadian producers remain a long way from profitability.
Sundial Growers is no exception. In its third quarter, even on an adjusted basis, Sundial posted an operating loss of nearly 6 million CAD. Net revenue was less than 13 million CAD. In other words, the best measure of operating profit still suggests margins near a loss of 50%.
Over time, this will change. Canadian players already are slashing production, while costs per gram continue to come down. Better branded products will draw customer loyalty and stronger pricing. Simply put, there’s still money to be made for the companies that prove to be winners.
What Does Sundial Do Well?
The problem for Sundial Growers stock is that it’s hard to see how the company can be one of those winners is such an intensely competitive industry.
Sundial pitches itself as offering brands that span the price spectrum, from value to premium. There’s some truth to that claim, and some logic to that strategy. But, again, net revenue in the third quarter was just 13 million CAD. Those sales were spread across five different brands.
An average of roughly 2.6 million CAD in sales per quarter per brand isn’t enough. Obviously, some brands may be stronger than others (Sundial hasn’t broken out exact figures), but none are likely to be much of a force in the industry so far.
Meanwhile, Sundial is focusing solely on flower and vapes. It’s largely out of the rush into “Cannabis 2.0” products like edibles that are supposed to expand the market.
This is a company that needs to grow its sales in order to get to profitability. But how is that supposed to happen? The brands aren’t strong enough. Sundial has slashed its debt this year, but it’s still selling stock to fund its cash burn.
We’ve seen this problem before. It’s impossible for a cannabis company to cut its way to growth. I don’t believe Sundial is strong enough to be an exception to that rule.
The Case for Sundial Growers Stock
To be fair, Sundial Growers stock can’t be written off just yet. We are likely to see more mergers in the industry, and it only takes one interested company to make a deal. I do believe the industry will grow at a faster clip going forward, with 2021 a potentially strong year. Perhaps Sundial can ride on the industry’s coattails next year.
I’d also expect we’ll see some big bursts in SNDL stock over time. Cannabis names have seen quite a bit of volatility in recent years. The low share price tempts some investors, and even more traders. Sundial shares recently saw a huge bounce from 24 cents on Nov. 23 to a close of 81 cents just six trading sessions later.
But that big burst already has reversed: Sundial Growers stock has dropped 47% from that peak. And that’s not terribly surprising. There’s enough here to make Sundial Growers stock look tempting as a buy. There’s not enough to convince investors to hold it for all that long.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now. As of this writing, Matt did not hold a position in any of the aforementioned securities.