Canadian pot producer Tilray Brands (TLRY -1.48% ) releases its third-quarter results on Wednesday before the bell. The stock was bright red and investors might be tempted to jump on the bandwagon.
But there are serious question marks surrounding the company that investors should consider before buying the stock. Below are three things to consider when releasing the earnings report, which could indicate whether the company is moving in the right direction and whether more acquisitions are on the horizon.
Gross Profit and Price Squeezes
A big problem in the industry is that there is considerable competition. A few quarters ago, Tilray CEO Irwin Simon called small producers “ankle-biters” who were taking market share from the company. And while the company is trying to increase its market share, it’s also trying not to be too aggressive on pricing. In the company’s most recent earnings call in January, management noted that in the Canadian market, Tilray only cut prices by 1.7%, while the market cut prices by 22.6%. . However, the company’s efforts to protect its margins could be tested again amid rising inflation and potentially even more price-conscious consumers than before.
Despite efforts to protect its margins, Tilray’s gross profit was still down in its latest quarter. For the period ending Nov. 30, 2021, gross profit of $32.8 million was lower than the $35.3 million the company reported in the prior year period. And this, despite a 20% increase in net income to $155.2 million.
This is an area investors will want to focus on, as deteriorating gross margins will make it harder for the company to cover its operating costs and continue its streak of positive adjusted earnings before interest, tax, depreciation and amortization (EBITDA). In the second quarter, its adjusted EBITDA profit of $13.8 million marked the 11th consecutive period in which Tilray Brands was in the black (on an adjusted EBITDA basis).
Cannabis revenue and market share
What happens with margins and prices will inevitably impact cannabis revenue. Last quarter, while other segments of its business (e.g., retail, wellness) showed stability, Tilray’s actual cannabis revenue declined from $70.4 million in the first quarter. quarter to $58.8 million in the second quarter.
The company’s retail market share has fallen to 12.8% (previously it was 16%), which is far from its goal of achieving 30% market share in Canada, which is a key to Tilray reaching its annual revenue goal of $4 billion by 2024.
If it fails to grow its market share significantly, investors should expect more mergers and acquisitions to help bolster sales. Most recently, last month, the cannabis company announced a strategic alliance with rival Hexo whereby it acquired $211 million of its senior convertible notes. Under the terms, Tilray could potentially own more than one-third of Hexo’s common stock if it elects to convert the notes.
While acquisitions can certainly help increase revenue, for investors it can also mean more cash burn and potential dilution.
Reductions in operating expenses
The only thing Tilray can do to protect its bottom line, regardless of what happens with sales and gross profit, is to minimize its operating costs. In the second quarter, it reported that cost synergies from the deal with Aphria (it closed in May 2021) generated nearly $36 million in cash savings up to that point. The company expects more synergies and says it is ahead of its $80 million goal.
It will be a challenge for Tilray to cut costs, especially if it pursues other acquisitions. In the second quarter, selling, marketing, general and administrative expenses totaled $50 million, more than the company’s gross profit of $32.8 million. The company needs both gross margin improvement and further operating expense cuts to at least give Tilray a chance to post an operating profit (last quarter the loss was 54 .7 million).
Should you buy Tilray shares?
Over the past month, shares of Tilray Brands have soared 38%, while the S&P500 increased by 4%. The reason for this optimism, however, probably has more to do with the hopes surrounding changes in US federal marijuana laws than with Tilray’s underlying business. Despite the recent surge, investors should proceed with caution here and adopt a wait-and-see approach as there are many question marks surrounding its business that make Tilray too risky to buy at this time. And even if the company does well in the third quarter, it’s unlikely to dispel all the concerns noted here.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.