Tilray Brands Inc (TLRY)

[FUNMAN]

Tilray CEO expects U.S. cannabis legalization in next 24 months

I hope it's sooner; before the 2022 elections. - FUNMAN

Jul. 13, 2021 4:21 PM ET
By: Brian Stewart, SA News Editor

https://seekingalpha.com/news/3714872-tilray-ceo-expects-us-cannabis-legalization-in-next-24-months

Irwin Simon, chairman and CEO of cannabis products maker Tilray (NASDAQ:TLRY), said Tuesday that he expects "something to happen" on federal U.S. legalization of cannabis in the next 24 months.

In an interview with CNBC, Simon pointed to surveys that show that 93% of voters want legalization and to the fact that more than 35 states currently allow either adult use or medical applications of the products.

"It's about time we get on with it," he said.

As a sign of movement on the issue, the Tilray CEO looked forward to a new bill expected from U.S. Sens. Chuck Schumer (D-N.Y.) and Cory Booker (D-.N.J.). He predicted that "a lot will change" with that proposed legislation.

Looking ahead, Simon asked shareholders in late June to approve an increase in the company's outstanding stock so that it could pursue acquisitions.

On Tuesday, Simon specifically cited the medical market in Europe as a prime target for potential M&A activities.

The Tilray CEO also pointed to the company's recent merger with SweetWater Brewing as another potential growth area. He explained that the purpose behind the combination was to create a distribution structure for CBD and THC beverages once the legal situation had clarified.

There is some skepticism about whether Tilray can break out of its Canadian roots.




Is Tilray Stock A Buy? It Will Take More Than Canada

https://seekingalpha.com/article/4434720-tilray-stock-buy

Summary

At the moment, the post-merger Tilray can't support the TLRY stock price.

But of course, that's not necessarily a problem yet, given the potential for expansion in the U.S. and other markets.

Those markets need to open as hoped — and Tilray needs to execute as planned.

Investors bullish on those aspects of the story should see Tilray stock as a buy, even with a recent rally. Others might well be much more cautious.

By any fundamental measure, Tilray, Inc. (TLRY) stock is overvalued based on its current performance. That's true even after adjusting pro forma numbers following its recently-closed merger with Aphria.

In fact, before the merger neither Tilray nor Aphria had accomplished much at all. Unlike most Canadian peers — including Tilray — Aphria did manage to post consistently positive Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization). But as Stone Fox Capital pointed out on this site in April, those positive adjusted profits often fell short of the company's expectations, including during Aphria's final quarter as an independent company. Free cash flow, meanwhile, has remained sharply negative.

Certainly, the two companies should be stronger together than apart, not the least because of a projected $81 million in post-merger cost synergies. But even accounting for those synergies, the incremental benefit from full-year performance of U.S.-based Sweetwater Brewing (acquired by Aphria in December), and the effect of the novel coronavirus pandemic, TLRY stock still looks rather expensive.

But, again, that's relative to current performance. And there's room for that performance to improve. Tilray itself sees the Canadian market growing significantly, and a path to sharply higher market share for the combined company. Opportunities abound overseas, most notably in terms of U.S. federal legalization. Even with TLRY stock up nearly 50% over the past month, there's potential upside if all works out.

That does seem like a big 'if', however. And the higher share price, in part (apparently) due to yet another meme stock rally, is a bit of impediment. Cannabis bulls still can, and probably should, see Tilray stock as attractive. For those more cautious toward the sector, however, it's difficult to pound the table too forcefully — yet.

What the Tilray Stock Price Means

Based on the diluted share count from the pro forma financials last month, Tilray had 410.86 million shares outstanding during the nine-month period ending Feb. 28. That share count implies a current market capitalization of nearly $8.2 billion. The actual share count does appear to be marginally higher, given that Tilray cited a similar market cap when the merger closed on May 3, with a lower TLRY stock price.

Using the more conservative figure, and adding net debt of $564 million (that includes contingent consideration of $60 million), Tilray's enterprise value sits at $8.74 billion.

Again, as far as the fundamentals go, that's a big number. Trailing twelve-month revenue is in the range of $770 million. (Tilray hasn't disclosed the actual figure, and the mismatch between the reporting period of the pre-merger companies makes a perfect comparison difficult.) So TLRY trades at more than 11x sales.

In the context of the sector, that multiple perhaps doesn't seem that high. Canopy Growth (CGC) and Cronos (CRON) both trade far higher on an EV/revenue basis. But Cronos, in particular, has an elevated multiple because of its strategic decisions, and for Tilray those sales aren't all the same. Nearly 40% come from the lower-margin, lower-growth distribution business (CC Pharma, which Aphria acquired in early 2019).

The same problem holds on an EBITDA basis. Tilray hasn't disclosed pro forma results for that metric, but combined trailing twelve-month results for the two companies get to just $18 million. A full year of Sweetwater results plus post-pandemic normalization might add in the range of $15 million (against ~$4 million-plus in its first few months). Aphria broke out losses of over $8 million on development efforts which will either bear fruits or fade away. And, as noted, the synergies should add $81 million.

That total still only gets the business to a pro forma $123 million. Using that potentially generous figure, TLRY stock trades at 71x EBITDA.

Here, too, on a sector basis the figure doesn't look all that bad. Canopy lost a seemingly incredible $340 million in its fiscal 2021 (ending March), even on an Adjusted EBITDA basis. That was actually $102 million better than FY20 performance.

The new Tilray seems to be the most profitable operator in the Canadian market. Given lower capital expenditures going forward as well as reduced interest expense after convertible debt was exchanged for equity last year, the baseline EBITDA does suggest the company should be in the black on a free cash flow basis, normalized for working capital effects.

On an absolute basis, however, the lesson is reasonably clear. At 11x revenue and 71x a generous reading of pro forma EBITDA, Tilray stock is priced for growth.

Why Was Tilray Stock Dropping Before This Rally?

Meanwhile, those multiples are higher than they were just a month ago. TLRY has rallied 45% since it hit a four-month low on May 13.

As with so many stocks in 2021, Reddit has been cited as a culprit. In recent weeks, TLRY has trended on the r/WallStreetBets subreddit. And the stock has seen huge retail-driven moves before.

Back in 2018, the stock soared to $300 before quickly collapsing. In February, TLRY saw another massive, yet short-lived rally, apparently because some traders believed high short interest was the catalyst for a squeeze. In fact, that interest was made up largely of merger arbitrageurs, who were capturing the pre-merger spread between TLRY and APHA. That spread ballooned to some 30% and Tilray stock closed near $64 on Feb. 10. Shares were nearly halved the next day and wound up falling more than 75% in three months.

So we've seen huge volatility here on multiple occasions. And the potential for another squeeze/bubble/mania (however an investor views it) can't be ignored.

That said, the gains over the past month can't be attributed just to retail buying. Volume hasn't increased to the exponential extent we've seen with other meme stocks:

Chart
Data by YCharts
one-month chart

The sector has moved higher:

Chart
Data by YCharts
one-month chart

And there's been some good news as well. Analysts have become more bullish, with a double upgrade from Jefferies followed by an outperform rating at Cowen. The sell-off to early May lows may have gone a bit too far.

From a distance, it's reasonably easy to write off TLRY. The fundamentals don't look great. The stock has a history of bubbly trading which seems to be repeating. The pre-merger Tilray was not a particularly impressive business, though the post-merger company is predominantly driven by the more profitable operations contributed by Aphria. (That's why Aphria shareholders received 62% of the shares of the combined company.)

That doesn't seem to be the correct way to view the stock, however. The merger does make some sense. Tilray will be profitable going forward, if initially only on an Adjusted EBITDA basis. The rally of the last month has some basis in fact, even if past moves probably didn't. Simply put, there's something here.

Management and the Tilray Stock Forecast

Indeed, if management forecasts play out, there's probably upside from the current price just shy of $20.

At the time of the merger in December, the companies said the combined operation would have had 17.3% market share in Canada between August and October 2020. By January, the figure had been raised to 20%, seven points higher than second-place Canopy.

Chief executive officer Irwin Simon has said he is targeting 30% share. Hitting that bogey alone moves revenue at least 50% higher, depending on the company's exact share at the moment.

Meanwhile, the Canadian market should grow as well. Simon has cited estimates that the market can reach $8 billion to $9 billion, against a current $3.6 billion annualizing recent monthly numbers. 30% of that market, plus Sweetwater and CC Pharma, gets revenue near or to $3 billion. Assume scale boosts margins from the current pro forma ~16% and it's reasonable to model EBITDA of $600 million or more in this scenario.

That's just from the Canadian market. Tilray has set itself up for the U.S. market. Sweetwater creates the ability to offer THC and CBD beverages. Its distribution is expanding north and west from its southern base (the brewery is based in Atlanta), and seems on track to be national or close by the time U.S. federal legalization arrives. CC Pharma provides a base in Europe; Aphria focused particularly on Germany. There are operations in South America as well (investors may remember that Aphria was the target of a short seller report which noted conflicts of interest in some of those acquisitions. Management was replaced, with Simon coming on board in 2019.)

This is the road map to upside in Tilray stock. The Canadian operations become the domestic leader and drive significant profitability as the market reaches its long-awaited potential. Assuming the company can hit that 30% market share target, there's a case that Canada alone could support the current valuation (~15x EBITDA). In that model, investors thus are getting, for free, the optionality from Europe, South America and, most importantly, the U.S. Given that the U.S. alone has a population nearly 9x that of Canada, the potential upside for TLRY is enormous.

Is TLRY Stock A Good Buy?

There are a number of concerns, however.

One is the short-term outlook. Again, there's some basis for the recent rally. But a 45% move in a month is notable, even for what historically has been one of the most volatile stocks in a volatile sector.

That rally raises a key near-term question: what catalyst is there to move the stock even higher? The Canadian market likely continues to struggle. Chief financial officer Carl Merton noted at a conference earlier this month that nearly one-fifth of the stores in Ontario had never had a single customer inside the store, due to restrictions surrounding the pandemic. The illicit market remains competitive as well.

Tilray in fact posted soft first quarter results. As Barron's noted, the company did so quietly, filing a Form 10-Q but no press release, and holding no conference call. It's unlikely that results from the combined company are going to impress until at least the second half of this year, which won't be apparent in earnings releases until early November. There's certainly the possibility of another Reddit-driven rally, but fundamentally it's difficult to see a spark particularly after the gains of the last few weeks.

From a long-term perspective, there's simply a lot of work to do relative to all of the potential profit drivers. The 30% share target is awfully aggressive in a hugely competitive Canadian market. Smaller companies appear to be gaining in recent months. Hexo (HEXO) has made a big acquisition. Sundial Growers (SNDL) is getting its act together. Canopy and Cronos are flush with cash. Keep share in the 20% range and the fundamental story here looks much less attractive.

There's also the question of whether the Canadian market can reach the projected $8 billion to $9 billion level. 'Black market' cannabis continues to maintain significant share, even as legalized operators have managed to find a pricing edge:

That pricing advantage should help the top line, but it also raises margin concerns. Lower pricing, the result of still-present overcapacity, is a huge risk to profits. Tilray's senior vice president of sales and marketing admitted as much in an interview with Mugglehead, and noted the company was focusing on packaging in a bid to cut costs.

That may not be enough. And it gets to the broad concern with the Canadian market: as yet, no one really has succeeded. Going back to September 2018, two weeks after Constellation Brands (STZ) (STZ.B) legitimized the sector by taking a large stake in Canopy, the Canadian operators have mostly destroyed investor capital:

Chart
Data by YCharts
Tilray stock has been the notable outlier, but even its gains have mostly come so far in 2021.

There are a host of reasons why Canadian cannabis stocks have disappointed, including the impact of the pandemic. Still, none of the operators has shown that it can generate consistent profitability. It thus seems aggressive to assume that any of them will, or to bet on Tilray moving profits up ~400% from current pro forma levels.

Risks abound overseas as well. The South American operations remain relatively small. Germany remains a medical-only market. Movement in the U.S., despite broad popular support, is anything but a foregone conclusion given a 50/50 Senate split, an early focus on 2022 (and 2024) elections, and general gridlock. Even assuming legalization, there's going to be a massive amount of capital going into the market from not only cash-rich Canopy and Cronos, but MSOs (multi-state operators) like Trulieve (OTCQX:TCNNF) and Curaleaf (OTCPK:CURLF). It's far from guaranteed that Tilray is a winner in the U.S., let alone the winner.

The Case for Caution

This can work, certainly. But it's not hard to see that, particularly since 2018, all of the cannabis companies have had a broadly similar plan: using an established, profitable base in Canada as a springboard to global growth.

To execute that plan, Tilray has to outperform numerous rivals. It has to battle consistent price compression in a market that looks far more commoditized than sector bulls believed it would be. Politicians worldwide need to cooperate. There's not even that much room for error: bear in mind that even pro forma the leverage ratio is over 4x, thanks to net debt of $500 million.

In that context, the rally of the last month matters. It's notably more difficult to support an enterprise value near $9 billion against the prior ~$6 billion. Back of the envelope, for Tilray stock to double from here the company needs to have a path to $1 billion in EBITDA.

It seems nearly impossible to reach that level in Canada alone, which wasn't necessarily the case a month ago. CC Pharma likely doesn't help much. (Aphria paid only about $30 million plus earnouts, and the distribution business generated just $10.5 million in EBITDA in fiscal 2020.)

The bull case here relies heavily on the U.S., plus markets like Germany and Brazil. And those markets at this point are basically shots in the dark.

Now, for investors who are bullish on the inevitability of global legalization, TLRY is one of the better stories. Simon seems worth betting on. The distribution built through Sweetwater would be advantage in the U.S. The product fit between the two companies is smart; as VP of sales Yeung noted, Tilray added beverages and edibles to the portfolio. The combined company does lead in Canada, which suggests it could lead in America.

Still, there's an awful lot of 'ifs' and 'coulds' in the story. And this so far has not been a sector where plans have panned out. Perhaps Tilray will change that. I'm not ready to take that bet just yet.

This article was written by

Vince Martin profile picture.
Vince Martin
6.41K Followers
I've been contributing to Seeking Alpha and other investment websites since 2011, with a general (though fa...
Long/Short Equity, Value, Gambling

Contributor Since 2011

I've been contributing to Seeking Alpha and other investment websites since 2011, with a general (though far from rigid) focus on value over growth. I got my Series 7 and 63 back in 1999, and watched the dot-com bubble peak and then burst in real time at a small, tech-focused retail brokerage in NYC.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.