A big reason many investors think Canadian pot producer Tilray Brands (NASDAQ: TLRY) is worth the risk is because of the potential upside if the U.S. legalizes marijuana. It would open up a large market for the cannabis company, one that could help it drastically improve its revenue growth.
But that doesn’t mean it would transform the risky business into a safe one. Here are three reasons marijuana legalization in the U.S. won’t solve Tilray’s problems.
1. The company’s cash burn may intensify
Tilray has been posting adjusted earnings numbers, but what’s much more important for cannabis investors to consider is the rate of cash burn. If a company is using up a lot of cash over the course of its operations, then there’s a risk that it will need to issue shares, and thus dilute its existing shareholders and put downward pressure on the stock price.
During the latest 12 month period, Tilray burned through $18 million in cash from its day-to-day operating activities. This doesn’t yet factor in how much it spends on capital expenditures and growth-related activities. Expanding into a hotly contested U.S. market would likely require greater expenditures, and thus result in a potentially much higher rate of cash burn. In order to chase that market share, the company may end up using up a whole lot more cash.
2. The company may sideline its move into alcohol for the purpose of going all-in on cannabis
In recent years Tilray has been acquiring alcoholic-beverage brands and businesses in an effort to not only diversify but expand. With the U.S. pot market off-limits, alcohol has been a key part of its growth strategy. And the beverage segment also has better margins than cannabis. In Tilray’s most recent quarter, which ended on Feb. 29, its adjusted gross margin for beverages was 38%, versus 33% for cannabis.
If Tilray were to go after the U.S. cannabis market, it may be tempted to focus less on alcohol in an effort to conserve cash — which, as noted in the previous point, could become a greater concern for the business. The result is that Tilray could end up becoming a less diverse business if it were to try and aggressively scale operations in the U.S.
Diversifying into alcohol has been positive for Tilray, and it’s one that may help it ultimately build a much more sustainable business in the long run. If it abandons that and goes after the cannabis market aggressively, Tilray may end up being an even riskier investment than it already is.
3. Tilray may aggressively pursue mergers and acquisitions
Tilray hasn’t been shy when it comes to acquisitions. In Canada, it acquired Hexo, a problematic and unprofitable cannabis company, for the sake of gaining market share. In 2021 it also acquired a majority position in the convertible notes of multi-state operator MedMen in the U.S. in the hopes of one day potentially acquiring the business and using it as a way to expand its operations south of the border if legalization takes place. MedMen, unfortunately, has turned out to be a bad investment, and now appears to have serious liquidity issues; it reportedly owes employees money, and has been closing stores.
The danger is that Tilray hasn’t exactly been a great judge of cannabis businesses in the past. If it were to pursue more risky acquisitions in the U.S., that may exacerbate its cash flow concerns and push back any hopes of profitability as well. Acquiring businesses for the sake of growth in an already troubled industry wouldn’t make Tilray a better buy.
Investors should steer clear of Tilray Brands stock
Tilray’s stock has fallen 90% during the past three years, and investors should be careful not to assume a recovery is just around the corner. I don’t think it’s likely that legalization will happen anytime soon in the U.S., but even if you disagree and think it’s probable, it’s important to consider the points above.
Although Tilray may have some exciting growth opportunities to pursue if the U.S. market opens up, that doesn’t mean this becomes a slam-dunk buy. The reason cannabis companies have such beaten-down valuations today is because many of them pursued a growth-at-all-costs strategy with little concern for cash burn and mounting losses. The risk is that Tilray could fall into that trap again if it were to chase growth opportunities in the U.S.
This stock is simply too risky for most investors to put into their portfolios. There are much better options out there for growth investors.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Tilray Brands. The Motley Fool has a disclosure policy.
3 Reasons Tilray Brands Investors Shouldn’t Assume U.S. Marijuana Legalization Would Fix the Stock’s Problems was originally published by The Motley Fool