Meme stocks came into the spotlight in early 2021, when retail investors gathered on message boards like Reddit’s WallStreetBets and decided to buy shares of the beaten-down but heavily shorted GameStop in order to force a short squeeze.
After GameStop, meme stock traders went on to target other heavily shorted stocks flirting with bankruptcy, forcing squeezes and allowing these companies to raise cash through equity sales at much higher prices. That essentially allowed several meme stock companies to attempt a transformation, given that their legacy businesses were having serious problems.
However, this summer’s meme stock resurgence doesn’t seem to be fundamentally based. Many meme stocks still trade at high valuations relative to current numbers, while others didn’t raise enough capital during 2021 to offset all their debt (I’m looking at you, AMC Entertainment).
However, there is one meme stock that actually does look appealing on a fundamental basis these days, and is therefore the only of the bunch I’d invest in today.
The tiny cannabis stock that roared
Before the meme stock craze, Sundial Growers, now rebranded as SNDL (SNDL 0.36%), was on the verge of bankruptcy. However, the meme craze allowed the company to sell stock and raise over $1 billion during 2021.
That equity raise allowed Sundial to pay off its debt, with lots of cash leftover to attempt a rebuild. The question is, how is the company allocating capital? Management did essentially four things with its meme-fueled riches, with three out of four being very smart, but the fourth still an open question.
The good: Liquor stores, a credit portfolio, and buybacks
One of the better uses of cash has been Sundial’s recent acquisition of Alcanna, announced in October 2021 but which closed in March of this year. Alcanna was important because its 171 liquor store footprint actually generates earnings and cash flow, unlike basically every Canadian cannabis retailer.
Alcanna also owns a 63% majority stake in Nova, a 78-store cannabis retailer under the “Value Buds” banner. However, the $25 million in annual cash flow from its liquor stores more than offset the $6.7 million in cannabis operating cash losses from Nova last year. In addition, that cash loss could turn into a profit, as SNDL believes it can achieve more than $15 million in synergies between Value Buds and SNDL’s existing 100-plus store Spiritleaf retail footprint.
While SNDL’s balance sheet cash is nice, it really helps to have a business that can throw off cash flow on a consistent basis. Considering just about every Canadian cannabis company burns cash, SNDL’s recurring cash flow is a huge advantage.
The second good thing SNDL management did was establish a joint venture with SunStream Bancorp, with the aim of investing in loans to U.S. cannabis companies. As of the second quarter, SNDL had invested some $490 million in SunStream. For the record, Canadian companies are not allowed to engage in plant-touching activities in the U.S., where it is still illegal.
However, lending through the SunStream JV is a savvy way to get around this limitation, while also generating handsome investment yields. As of the end of 2021, the average hold-to-maturity yield on the U.S. credit portfolio was 16% as of the year end 2021. In addition, SNDL has invested in credits in the Canadian cannabis industry.
Since SNDL is also an operator, it has several advantages. First, it can glean lots of operational insights from its investees. However, should its investee companies run into trouble and restructure or file for bankruptcy, Sundial, as a creditor, has the potential to pick up assets on the cheap. So, it’s a bit of a “heads I win, tails I also win” scenario.
On the recent conference call with analysts, CEO Zach George said, “While our goal is to generate attractive returns as a strategic capital partner for these borrowers, in certain cases we may see defaults or other restructurings create an opportunity for SNDL to gain a meaningful operating footprint in a single or multi-state format.”
While SNDL would currently be prevented from taking over a U.S. cannabis operator as a Nasdaq-listed company, there are potentially ways to structure things so it could have exposure to a U.S. business, perhaps through SunStream (which is private) with a condition to take ownership if and when cannabis is legalized in the U.S.
Finally, SNDL’s management has recently been repurchasing shares. Given that the stock now trades below the value of its cash, credit, and marketable security investments, and that the company still has an ample $335 million in cash as of Aug. 11, repurchasing some shares at a big discount to book value seems like another prudent use of cash.
The other strategic action is an open question
While these moves seem fairly defensive in an industry that’s anything but, Sundial is trying to grow itself into one of the largest Canadian cannabis companies, aggressively pursuing a vertically integrated strategy.
To this end, Sundial has made some equity investments in Canadian cannabis companies, and just recently purchased the 90% of Valens Company it didn’t already own for $138 million in stock.
Although the implied purchase price of $1.26 seems cheap, as it’s down around 70% since The Valens Company started trading on the Nasdaq last year, SNDL is purchasing the company with its own shares, which are trading below book value. The combined company will still be trading below book even after the acquisition, but it’s not clear why SNDL didn’t use some of its extra cash instead.
Furthermore, cannabis equities have done terribly, and The Valens Company seemed to be struggling at the time, with a widening EBITDA loss of $17.6 million in the recent quarter.
SNDL management does believe it can ultimately achieve $15 billion in synergies, while expanding its complementary offerings to different segments. While Sundial had been focused on premium cannabis and retail, The Valens Company outsources its flower production from contract manufacturers and specializes in “2.0” products, including vapes, edibles, and drinks.
While there could be something there, investing in the equity of money-losing peers is riskier than the other three strategic moves — especially when using your cheap stock to do it.
The bottom line
We will have to see how the Valens acquisition works out, and if SNDL can succeed in consolidating a struggling Canadian cannabis industry, which has basically been a disaster. While that main goal is a longer-term endeavor, in the meantime, SNDL has the cash-producing liquor business, interest income from the SunStream JV, and a large pile of cash relative to competitors. That puts it in a strong strategic position; whether management squanders the opportunity or takes advantage of it remains to be seen.
Meanwhile, the stock is currently trading below book value, which consists mostly of cash and loans, so SNDL’s downside seems fairly protected in the near-term at least. That downside protection is why it’s the only meme stock I’d invest in at the moment — and if management’s ambitions in the North American cannabis industry eventually work out, there could be significant upside.