The greatest challenge for Tilray (TLRY) is its inability to live up to the unwarranted hype that accompanied the aftermath of its IPO, when it soared rapidly to over $200 per share for no reason related to fundamentals.
The good news concerning that big splash is it secured itself a place in the media limelight. The bad news is it generated such high expectations that there was nowhere to go but down after the hype was over.
Now that the company is settling down to build a legitimate cannabis business, it is now being scrutinized in a similar fashion all companies should be, and being somewhat late to the game, it is working hard to catch up with the market leaders.
Since I view Tilray as a late entry into the competitive cannabis sector, I also look at the company as one that is in the same place market leaders were about a year ago, with the exception it gets to sell recreational pot to the Canadian market.
Why its earnings report doesn’t bother me
After the company released its earnings, almost all the financial media led their reports with the fact Tilray had a larger-than-expected loss.
While I understand why that happened, I do believe investors need to look at Tilray a little different than the cannabis companies that have been competing in the sector longer.
For example, the market largely ignored the importance of the 371 percent increase in year-over-year revenue for the quarter, reaching C60.9 million, or US$45.9 million. Not including excise tax, it was C55.8 million, or US$42 million.
Just a quarter or two ago, this would have been enough to give the stock a nice boost. But recently, I believe because of overall negative economic sentiment from the trade wars and flight to safety, the market is now looking for profitability from the company specifically and cannabis sector in general.
For that reason, companies that are able to increase revenue while showing a clear path to profitability, have started to be rewarded by the market.
With that in mind, Tilray isn’t ready yet to fill that bill, as it generated a net loss of $35.1 million, or $0.36 per share in the quarter, against the $12.8 million or $0.17 per share loss in the same reporting period last year. Adjusted EBITDA feill to a loss $17.9 million against $4.7 million loss last year in the same quarter.
The losses came from a less favorable product mix, with the increase of revenue coming from low-price/low-margin recreational pot; spending on growth; international expansion; convertible notes interest expense; and costs associated with adding Manitoba Harvest and Natura businesses to the company portfolio.
If Tilray had been a little further along in its business life, this would be somewhat concerning, in a similar way Canopy Growth diasppointed in its last earnings report. But since I view Tilray as being at least a couple of quarters behind the cannabis sector in general, this is close to what I would expect the company to be doing.
Why the CEOs comments on growth are correct
Chief Executive Officer Brendan Kennedy made some comments on the consistent losses the company has been experiencing, and I am in agreement with his assessment of the market as it relates to the company at this time.
He said this:
“Once in your lifetime, if you’re lucky, you see an entire industry emerge overnight and if you want to dominate that global industry, you’d be constraining yourself if you were focused on profitability at this point.”
This is similar in attitude to Aurora Cannabis management, which aggressively focused on expansion to the point it is poised to vastly outproduce its competitors by a wide margin within a couple of quarters. It’s not far being profitable, which is why it’s going to catch a bid once it’s confirmed it is growing revenue while continuing to lower margins and costs.
Where Tilray is today in its growth cycle, I see revenue and expansion being far more important than profitability at this time. Other companies that are further along and at or near profitability, should be rewarded more by the market than those that have no visible path to generating a profit.
Tilray wants to become one of the leading cannabis companies in the world. To achieve that it has to, for now, continue in the direction it is going. Once the foundation is laid, it will be able to focus more on lowering costs and margins, while generating a profit. That time isn’t here yet, and I don’t expect it to be at this time.
Even the company stating it should reach profitability in Canada by the end of 2019 isn’t likely to happen in my view. But if it does, it would be a major achievement that will reward shareholders nicely. I’m sceptical primarily because of its increase in recreational pot sales and its reliance on third-party cannabis suppliers to do most of its business.
To me, as long as it continue to show it has a path to profitability, and confirms it is able to execute on its plan, I don’t think the company get hit too hard in the near term.
On the other hand, if it doesn’t execute and underperforms on revenue and earnings, it’s going to go a lot lower than it is today.
Conclusion
A major problem for Tilray since its IPO is the huge success it enjoyed as far as quickly attracting investors from the start, which drove the share price of the company up far beyond its value. I think that remains a problem to this day, and the company could use more of a correction to align itself with what is really worth.
Even so, I like the overall strategy Tilray management is taking. It is aggressively pursuing international growth, and Kennedy stated he believes the company will enter anywhere from four to six new medical cannabis markets over the next two to three quarters.
The major concern I have for Tilray is its need to acquire much of it cannabis from third-party suppliers. That has increased costs, and if something were to disrupt the supply chain, the company is vulnerable to potential extreme pressure. While I have no doubt there are measures in place to handle this, it will continue to be a drag on the company as prices continue to rise.
I’m not real bullish on Tilray as it stands today, but if it executes on its business plan, and is able to manage costs from third-party suppliers adequately, it could surprise a lot of investors in the quarters ahead.
For now, Tilray is a work in progress, and should be considered more of a late entry into the competitive field. That means revenue should be the key metric to follow in the near term, and if it’s able to scale to meaningful levels, it should result in it lowering costs and eventually generating a profit.
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