Welcome to our Cannabis Earnings series where we break down the latest earnings to help you focus on the most important topics.
Tilray (TLRY) reported 2020 Q1 results that showed a stabilization around the current trend line. However, the business is still difficult to achieve profitability and positive cash flow without a step-change in its revenue. With the Canadian market struggling almost two years into legalization and the international markets slow to develop, we think the outlook remains tilted towards the downside in the near-term. Funding has also emerged as a concern at Tilray although not as astute as some other LPs.
(All amounts in US$)
Lack of Growth
Tilray reported 2020 Q1 results on May 11 and it has shown a small increase in revenue as growth in hemp outpaced the uptick in cannabis. Cannabis revenue increased by 9% in Q1 following a 20% decline in the previous quarter. Manitoba Harvest recorded a sizeable increase in revenue and hemp sales actually carry a higher gross margin compared to cannabis. The total gross margin fell to 21% due to a $4 million inventory adjustment. Without the inventory impairment, gross margins could have been 29% which is a partial recovery from the previous quarter. Tilray has been targeting higher sales from its international cannabis segment which will contribute positively to the consolidated margin. Despite still being a small part of the overall segment, Tilray has seen more success in its European sales and it has been spending more capital developing assets over there.
Tilray sold 5,794 kg of cannabis in Q1 which is a significant decline from the previous quarter due to no more bulk sales. As the market remains oversupplied, many LPs have stopped bulk sales amid very low wholesale pricing. That is why inventory write-down will remain a recurring theme for the next few quarters as production outpace sales.
(Source: Public Filings)
Liquidity and Balance Sheet
Tilray has been trying to cut back spending and stem cash outflows as the industry grapples with a bleak capital raising environment. Operating cash outflows decreased from $91 million in Q4 2019 to $54 million in Q1 2020. Capital expenditures were $18 million which is similar to previous quarters. The company didn’t make new acquisitions. The improvement in operating cash flow was due to reductions in SG&A, not revenue.
(Source: Public Filings)
Management provided 2020 cash flow outlook during the Q1 conference call and it expects operating cash outflows of $35-$45 million, capital expenditures of $40-$45 million, debt payments of $40 million, for a total use of cash of $110-$125 million. With $174 million of cash on hand, the company will likely require additional capital raise at some point this year. During the quarter, Tilray raised $90 million by selling shares at $4.76 per share and has secured a $60 million senior secured credit facility bearing rates at benchmark plus 8.05%. We also think management is likely too optimistic about its operating cash flow. Given Q1 already saw $54 million of negative CFO, Tilray is expecting to be cash flow positive for the remainder of the year. Given the lack of top-line growth and COVID-19 impact, we think there are significant risks that more cash will be needed than management indicated.
Tilray has a market cap of $978 million and trades at an EV/Sales of 11x which is at the high end of its peers. Compared to peers that do not have a strategic investor, Aphria (APHA) trades at 5.7x, and Aurora (ACB) trades at 7.6x. We think Tilray’s premium is not warranted given that its balance sheet is much weaker than Aphria, although better than the struggling Aurora, and its revenue is smaller than both. With an unclear path to profitability and likely requirement for additional capital, we think Tilray’s valuation remains speculative and implies substantial improvement in its future performance.
Tilray’s Q1 results were in-line with other LPs as the industry as a whole saw robust demand during the pandemic. Revenue also increased generally due to the launch of 2.0 products and more retail outlets opened across the nation. However, the growth was underwhelming after taking into account the expectations for 2.0 projects. One of the key catalysts for cannabis stocks was the launch of edibles and beverages which had the promise of unleashing a wave of growth in consumer demand. While sales increased, most LPs indicated that the new products only had a limited impact on their top-lines so far. Whether LPs could drive step-change in their revenue model will determine the fate of the whole sector. For Tilray specifically, we think the focus on EBITDA break-even and cash flow burn will remain important to investors. Given the lack of growth levers and continued pressure to cut costs aggressively, we believe Tilray shares remain speculative at current levels. We prefer high-quality U.S. cannabis operators that have superior growth profile, solid balance sheet, and more attractive valuation.
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.