Tilray: What is holding up the stock?

There is a riddle going around the investment world. It goes something like this. In a red hot sector, when was the last time the second largest player dramatically underperformed its peer group and lost money for investors? Tilray Inc. (NASDAQ:TLRY) may be the first. The question is whether the worst is over.

Fourth quarter and full 2018 results are scheduled to be released after the close today. This will provide some clues. A dozen Wall Street type firms well follow the stock. The last two quarters wound up disappointing analysts. This time around the expectations run $15-$16 million in revenues and a per-share loss of $0.05-$0.06.

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Tilray, which is headquartered in Nanaimo, Canada, presents itself as a world leader in cannabis engaging in the research, cultivation, processing, and distribution of medical cannabis. The company is a peddler of its products in Argentina, Australia, Canada, Chile, Croatia, Cyprus, the Czech Republic, Germany, New Zealand, and South Africa.

This amounts to developing and servicing a substantial supply chain. It seems to be part of the problem. Included in the third quarter analyst call, the company admitted that the amount of recreational cannabis sold didn’t amount to a Canadian nickel. Admittedly, there were only two weeks where recreational pot was legal. But the whole Canadian cannabis world had plenty of time to gear up for legalization.

The fourth quarter has been a busy time for the company. On October 18 TLRY floated a $475 million five year convertible note deal, paying 5 percent. They shelled out $26 million to acquire Natura Naturals, a Canadian cannabis producer. But that may not solve the inability to produce enough cannabis on its own. Efforts to locate quality recreational cannabis from outside suppliers so far has gone nowhere. The problem seems to be finding just the right quality.

So today’s conference call promises to be well attended. For a moment let’s suppose Tilray reports $15-$16 million and per share losses of $0.05-$0.06. Unless there is an answer to the supply chain problem, the numbers won’t really matter.

How much is enough?

Tilray stock is currently valued at approximately 235 times revenues. A reasonable question is, how fast should investors paying these prices expect TLRY to grow and for how long?

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A generous valuation for a high growth company might be where the market value equals 150-200 percent of revenues. Based on this method, TLRYs current annual revenues of about $40 million would need to grow 50 percent annually for the next ten years. That is a tall order.

I was not born a pessimist so anything is possible. However, for TLRY to grow into its current value is going to require a far greater amount of capacity than at present.

Margin trends going the wrong way

When any commodity is in short supply, prices typically rise along with profitability. Gross margins, however, appear to be trending in the opposite direction. For the nine months ending September, Tilray reported GM of 40.2 — down from 54.5 percent in the year-earlier period. Most of the drop came in Q3 when just 31 percent of every revenue dollar covered production costs.

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This may be one of the most important questions when management reports year-end financials. Can the company add capacity both quickly and profitably? We will be anxious to learn the answer.

Wall Street isn’t raving over Tilray either

In spite of underperforming its peers, it could be argued that TLRY stock continues to be overvalued. Wall Street analysts pretty much concur with this. Of the 15 opinions, nine analysts recommend either underweighting (that is a coward’s way of saying SELL) or rank it an outright sell. These are independent judgments.

 

I do not have a position in TLRY of any type, long or short. Furthermore, nobody is paying me to influence my analysis.

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