The more popular an investment theme becomes, the more likely retail investors get burned. Hype around any particular thesis is often driven by niche pundits who spout every bullish point they can dream up in newsletters that double as promotion platforms. That’s why we only invest in a thesis after heavily scrutinizing the space, and then subjecting the leader(s) to an even more critical eye. Still, it’s likely some firms will inevitably pull a Bind Therapeutics.
It’s hard to think of an investment theme that’s wreaked more havoc among newbie investors than cannabis. At peak hype in late 2018, Canadian cannabis darling Tilray (TLRY) traded above $148 a share in the months following their IPO. Since then, shares have fallen nearly 98% to trade at around $3.36 a share giving the company a market cap of just over two billion dollars. With a simple valuation ratio of 3.4, some subscribers have rightfully inquired as to whether there’s value to be had in Tilray stock.
About Tilray Stock
Our piece on How Will Weed Stocks Handle a Bear Market? discussed how cannabis may not provide the same sort of bear market invincibility as other sin stocks do. The low valuations seen across the board hint that institutional investors don’t see a lot of future growth potential for cannabis. Being that Tilray is a Canadian firm, the opportunity in their backyard pales in comparison to the one across the southern border. It’s why we believe large U.S. multistate operators present the best opportunity for investing in the growth of cannabis. When we say “large,” that word needs to be qualified. Eight of the largest cannabis companies in the world have a collective market cap of just over $15 billion.
While Tilray notes 56% of revenues coming from outside North America, the amount applicable to cannabis is much smaller. Only $10.42 million in revenues – about 14% of cannabis revenues – are international, while the vast majority comes from Canada – recreational use (77%) and medical use (9%). Given these metrics, Tilray isn’t driving a meaningful amount of revenue from the United States, a country with the biggest total addressable market (TAM) by a long shot.
On a quarterly basis, Tilray’s revenue growth appears to have stalled following their merger with Aphria which closed in Spring of last year.
Unlike other cannabis firms we’ve looked at, Tilray segments their revenues into four handy buckets seen below along with the gross margins for each (data is from Q2-2022 earnings report in USD millions).
|Revenue Minus Taxes||COGS||Gross Margin|
Let’s take a closer look at each revenue segment.
What Tilray Actually Does
The most profitable revenue segment, cannabis, is down 17% from last quarter which brings up a major problem. Those looking to invest in the growth of cannabis should note that only 38% of Tilray’s revenues last quarter provided that exposure. The bulls will correctly argue that this provides a diversification effect, but it also serves to reduce the “pure-play-ness” of the investment. It’s like puffing a joint and not inhaling. Tilray looks more like a conglomerate with a cannabis business.
The remaining segments aren’t overly compelling. If “distribution operations” is what it says on the tin, then it’s a business that involves Tilray acting as a middleman between producers and sellers. Typically, such activities are low margin, and Tilray’s 9% gross margin supports that claim (down from 12% quarter-over-quarter). As for wellness, that’s comprised of Manitoba Harvest, an acquired asset which sells expensive hemp food products and supplements that might be found in overpriced smoothies at your local farmer’s market.
Revenues for the hemp segment fell 10% compared to the same quarter last year, and more of that should be expected as consumers experience the effects of a recession that – at least in the United States – is either here or never coming, depending on which political party you talk to. Hemp superfoods are loosely connected to the cannabis theme but have nothing to do with pending legalization, the sole reason why investors are so bullish on cannabis stocks. Overpriced hemp supplements have been around since the 1960s and they’re not something we want investment exposure to.
Monitoring the growth of Tilray’s revenue segments will provide investors clues as to where the company is expanding or contracting. A breakdown of revenue segments by country would be useful to show what they’re doing and where. The company-wide blended gross margin of 32% isn’t all that great, which is a good segue into talking about survivability.
The hype surrounding cannabis led many firms to expand through rapid acquisitions while paying questionable amounts of money for the privilege. The result was lots of goodwill and intangible assets being allocated to balance sheets which could represent future write offs (impairment charges in industry parlance) that tend to decimate earnings. Worse, they send a message to investors that the management team squandered precious capital by overpaying for an asset. Tilray has about $3.8 billion of intangible assets and goodwill, and unsurprisingly, most are related to their cannabis segment.
Another side effect of acquisition binges is the issuance of debt. Tilray has $568 million in long-term debt on their books which is offset by $490 million in cash on hand. Their cash flow from operations (the amount of cash they burned through last quarter) came in at around $46 million. That means they have about 10 more quarters of runway with current cash on hand. Raising more capital at such depressed share prices isn’t optimal, while additional debt isn’t going to be provided at favorable terms.
When evaluating all cannabis stocks out there, investors need to focus on gross margin and runway to ensure survivability as margins get compressed and the black market steals back market share.
Investing in Tilray
Tilray appears to have used too broad a net when crafting their acquisition strategy. Investing in ancillary cannabis businesses might have made sense for Tilray, but instead, they overpaid for cannabis expansion and started pursuing unrelated verticals. The end result is a conglomerate-type business with exposure to hard spirits, hemp foods, and a low-margin distribution business. A lack of pure-play exposure, along with a giant chunk of goodwill, are reasons enough for us to avoid Tilray stock going forward.
Lastly, we want to reiterate our concerns that the increased laxing of cannabis regulations will lead to more individuals turning to “farming” and an increased comfortability for black market stakeholders. You can’t grow a few tobacco plants to produce your own cigarettes, but getting a couple pot plants to spew forth several pounds of Satan’s lettuce every year isn’t that tough – so we’re told. Furthermore, a recession will force consumers to be more price sensitive which will put pressure on margins and encourage black market trade. Tilray has already made mention in their last 10-Q of “a change in consumer trends toward lower margin products.” Vertically integrated producers will have an advantage as they can best compete on cost.
In looking at the largest cannabis companies, valuation seem to be in line with the exception of Cronos Group, perhaps because they received a $1.8 billion investment from Altria Group (MO) in 2019, an $80 billion purveyor of tobacco products.
|Market Cap||Last Quarter Revs||Simple Valuation Ratio|
|Green Thumb Industries||2.40||0.254||2.4|
The group average is 2.3 if we exclude Cronos Group as an outlier. For Tilray to reach that valuation based on last quarter’s revenues, shares would need to trade at $2.30, all things being equal. In other words, there’s no good reason to call a bottom on the recent share price levels.
More consolidation is needed so that a cannabis leader can emerge and use economies of scale to crowd out the stragglers. Revenue growth may stall across the board, so companies that come out the other end in good financial condition will be best served to consolidate distressed assets at bargain prices. Tilray isn’t a cannabis leader by market cap or revenues, but their international exposure helps them stand out among a crowded field. The showstoppers here are that only 38% of last quarter’s revenues come from cannabis, and they’re missing out on the biggest opportunity out there – the legalization of cannabis in the United States.
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