Tilray: Struggling Cannabis Giant Needs A Turnaround

Tilray reported unusually high gross and operating costs due to impairment of inventory and other assets. Source: Author based on company filings.

Summary

Tilray (TLRY) is a Seattle-based Canadian cannabis company which generates about two-thirds of its revenue from cannabis sales and one-third from hemp food products. After a monstrous stock price run-up in late 2018, Tilray’s shares have been in continuous decline, dropping over 97% from their intra-day $300 high.

Tilray’s financial performance has not been impressive. While the company has grown its revenue, it also suffers from poor gross margins and very high operating costs. In the fourth quarter, Tilray recorded $180 million in impairments of inventory and assets. Even without that impairment, the company would have reported its worst-ever operating loss due to low margins and high spending. Among other costs, Tilray has rewarded its management with $61 million in compensation over the past two years. These costs have contributed to a rapidly-collapsing cash position, with cash falling from $517 million to $97 million in one year. Tilray also owes $450 million in debt due in 2023.

Despite this, Tilray trades at a slight premium to other Canadian cannabis companies. It is unclear what Tilray has done to warrant this premium pricing, but I do not plan to pay a premium to invest in this troubled company.

Seattle-based Canadian Cannabis Producer

Tilray is a U.S.-owned cannabis company which is ostensibly headquartered in Nanaimo, BC, but is run out of Seattle, WA. The company was founded by, is run by leadership from, and was majority owned by Privateer Holdings, a Seattle-based venture capital firm. Tilray and Privateer were merged in December, allowing Privateer’s owners to own Tilray shares directly. These shares represent 77% ownership of Tilray and are subject to a two-year lockup agreement ending in December 2021. Under this agreement, 11 million shares were unlocked in April. More shares will be unlocked each quarter.

Executive	Role	2019	2018	2017
Brendan Kennedy	CEO, President	$3,480,910	$31,817,459	$375,000
Edward Pastorius Jr	CRO	$4,017,910	$2,771,361	$286,000
Mask Castaneda	Former CFO	$10,127,314	$4,494,909
Andrew Pucher	CCDO	$4,495,131
Kathryn Dickson	M.H. President	$11,771
	Totals	$22,133,036	$39,083,729	$661,000

Source: Company filings.

Tilray’s five executives received approximately $22 million in compensation in 2019, which was considerably less than they received the previous year. Executive compensation was lower partly due to Tilray’s stock declining 76% during the 2019. Most of this compensation is non-cash compensation through stock options and stock awards.

Tilray was founded as a Canadian Licensed Producer (“LP”), growing and selling medical cannabis in Canada. Tilray added recreational cannabis sales upon legalization in October 2018 and expanded their revenue base through the C$419 million acquisition of Manitoba Harvest in February 2019. Manitoba Harvest makes a variety of hemp-based products including Hemp Hearts, Hemp Oil, and Hemp Year! granola. The majority of Manitoba Harvest’s products use hemp for fiber and protein and do not include CBD, although they also use the brand for CBD products.

Tilray earned about two-thirds of their revenue from selling cannabis last year and one-third from selling hemp food products like hemp seeds and hemp granola. Source: Author based on company filings.

Tilray earns roughly two-thirds of their revenue from selling cannabis and about one-third from Manitoba Harvest’s hemp foods business.

Manitoba Harvest: The Manitoba Harvest business appears to be relatively low-margin and relatively low growth. Since its acquisition at the end of February, the hemp foods business has generated $60 million of sales, suggesting a $72 million run-rate and with no noticeable growth in their short publicly-reported life. Looking forward, Tilray hopes this segment will grow with increased household use of hemp food products and through the launch of CBD products in the United States.

During the past year, the Manitoba Harvest business generated gross profits of 31%. Those would have been 43% but the company had to impair some of its CBD and protein powder inventory. Management put the blame for CBD impairment on the FDA and their slow pace for adopting CBD guidelines.

Tilray sells cannabis primarily in Canada. Canadian recreational cannabis sales nearly tripled from January 2019 to January 2020. Source: The Growth Operation Canadian Cannabis Sales Data.

Cannabis: Tilray’s cannabis business is higher growth but, thus far, also has low margins.

Tilray primarily sells cannabis into the Canadian recreational cannabis market. That market under-performed analyst expectations last year, but is growing rapidly with sales today almost triple those of one year ago. Tilray’s sales are likely to approximately track the growth of this market as a whole. Recreational sales in Canada are expected to more than double in 2020, up to C$2.5 billion from C$1.2 billion in 2019. Sales are projected to grow further to C$4.1 billion in 2021, although these forecasts have been amended frequently (usually downward), so may be unreliable. Tilray also services the European medical cannabis market through a cultivation facility in Portugal. The growth of that market will also help Tilray to grow over the next several years.

Tilray’s cannabis margins are lower than their peers partly due to relying on cannabis purchased at wholesale prices. In 2019, Tilray earned -39% gross margins on cannabis due to impairing the value of their inventory. Without those impairments, the company earned 20% gross margins. These are among the lowest gross margins in the Canadian cannabis sector while low-cost growers like Aphria and Village Farms are able to earn much better gross margins.

Tilray has generated an operating loss in each of the past 12 quarters. Source: Author based on company filings.

Too much spending: Like most Canadian cannabis companies, Tilray has bloated operating costs which preclude profitability.

In its fourth quarter, Tilray recorded $112 million worth of asset impairment. This impairment was based on poor anticipated performance of Tilray’s licensing deal with Authentic Brands Group (“ABG”). Under that deal, Tilray agreed to pay ABG a minimum of $10 million per year for ten years and to pay ABG $100 million initially and up to $250 million in cash and stock. In exchange, Tilray would be entitled to use ABG’s brands to develop cannabis and CBD products in Canada and that United States. That deal has not paid off as Tilray’s management anticipated, leading to a $112 million impairment in the fourth quarter. In January, Tilray amended the agreement with ABG, discontinuing the $10 million per year minimum payment.

Impairment aside, Tilray spent $70 million in the fourth quarter on operating costs excluding one-time items. Given sales of only $47 million and gross profit (also before impairment) of only $11 million, Tilray accumulated large operating losses–the largest in company history–even because including the $180 million in impairment costs of inventory and assets.

As with many Canadian LPs and some United States MSOs, Tilray must significantly cut spending to achieve favorable results for its shareholders.

Tilray is burning through cash rapidly with over $100 million in free cash burn in two quarters this year. Source: Author based on company filings.

Cash burn and balance sheet: Tilray is burning through cash rapidly and their balance sheet has rapidly deteriorated due to this spending.

Tilray’s free cash flow burn reached its apex in the fourth quarter of 2019, with cash burn of $114 million. Most of this cash burn came from operational losses. Over the full year, Tilray burned through $332 million of free cash flow.

Tilray ended 2018 with $517 million of cash and short-term investments offset by $450 million of convertible notes. Those notes are functionally not convertible, as they were issued while stock prices were exorbitant and convert as an unrealistic $167.41 per share. Those notes mature in 2023, so will not imminently lead to insolvency.

Tilray’s $517 million has dwindled rapidly. Through the course of 2019, Tilray spent its way down to a balance of $97 million–less than one quarter’s worth of cash burn.

To fund its continued cash burn, Tilray sold $90 million of equity in March. The company sold 19 million shares and 19 million warrants for $4.76 per share. These warrants are exercisable for $5.95 per share with a five year duration, although their holders cannot convert them until September at the earliest. These warrants are currently in the money. These shares and warrants, collectively, represent approximately 37% dilution if the warrants are exercised.

Thoughts

Tilray trades at one of the highest EV/sales ratios in its peer group. Source: The Growth Operation Canadian LP Comparison.

Too expensive: Tilray has an enterprise value of about $1.4 billion. Analysts expect trailing sales of $220 million to grow 8% to $237 million in the next year. Analysts further expect Tilray to report adjusted EBITDA losses for the next six quarters, becoming adjusted EBITDA profitable in late 2021.

Compared to its peers, Tilray is one of the most expensive Canadian LPs, with its cost only trailing that of Canopy Growth.

In my view, this premium valuation is unjustified due to Tilray’s (1) lower growth than peers, (2) reliance on non-cannabis revenue in a segment with relatively low barriers to entry, (3) lower gross margins than peers, (4) continued high operating costs and cash burn, (5) high debt load, and (6) continued dilution to fund operations.

For at least those reasons, I will invest my money elsewhere, be it in other cannabis stocks or other sectors which are more likely to recover well as the world slowly moved past COVID-19 lock-downs and the ensuring economic damage.

Happy investing!

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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.