Tilray (NASDAQ:TLRY) gained wide-spread attention in 2018 as cannabis investing gained traction, and the stock remained significantly volatile throughout the year. There must be investors who made significant gains by investing/trading Tilray, and others who lost significant amounts from doing the same.

The cannabis industry is expected to grow in leaps and bounces for many decades to come. In this analysis, Dilly’s Research breaks down Tilray to assess its suitability to your portfolio.

TLRY stock price movement since its IPO in July 2018

Source – Morningstar

Despite the significant decline in share price over the last many months, Tilray has still trading almost 200% higher than the price at which Tilray opened trading back in July.

What is Tilray?

Tilray Incorporation is engaged in the sale and development of medical cannabis. As such, the company manufactures cannabis based medicines, drugs, drops, and oil products.

Tilray has two types of products in its arsenal.

1. Extracts
2. Dried cannabis

Extracts

Source – Tilray

Dried cannabis

Tilray derives its revenues primarily from Canada, which should not come as a surprise considering the legalization of cannabis in Canada. However, the company is focused on expanding into other regions, which requires regulatory approval and significant investments as well.

Analysis of Tilray’s financial statements

If there is one thing that is capable of stock market returns other than the financial performance of a company, that certainly has to be the investor sentiment toward the growth prospects of a company. There have been many incidents where the stock market price deviated significantly from the respective intrinsic value of the stock due to this very reason, and often this ended up resulting in massive losses for investors.

Tilray is operating in an industry that has a lot of hype, and investors are generally bullish on this industry, and this might lead many investors to invest in the cannabis sector without paying much attention to what is actually happening in the company they are about to invest in. This is a costly mistake, and at Dilly’s Research, we want to help investors avoid such costly mistakes.

Even though short-term price movements could drastically deviate from the intrinsic value of Tilray, in the long-term, the market price is expected to converge with the real value of the company.

Tilray’s topline has grown considerably over the last couple of years, and this falls in line with the growth of the cannabis industry and the regulatory framework. The topline growth is one thing the management has consistently reminded investors about, probably due to the fact that there is nothing much to offer from other financial performance metrics.

The revenue growth might look attractive to investors, which it is, but looking at a stand-alone measure reveals only a little about a company. Along with the revenue growth seen over the last couple of years, profits margins have compressed significantly, and this has elevated the losses of the company substantially. Ideally, when revenue is growing, as investors we like to see margin expansion as this enhances the profitability of the company. That said, it’s kind of natural to see high-growth companies failing to increase their profitability in the early stages of their businesses as well. We will delve into these growth aspects of Tilray soon.

The deteriorating margin environment is certainly not something investors want to see for a prolonged time period, and we can analyze whether the future profit margin outlook is promising by evaluating various determinants such as company growth expectations and pricing strategies.

The losses of the company elevated over the last couple of years despite revenue growth, which can be directly attributed to the declining profit margins.

A quick look at the income statements reveals the elevated cost structure of the firm, and these significantly higher costs are making life difficult for Tilray to become profitable in the short-term. Operating costs are nearly as double the value of revenues, and 3 folds the reported gross profit figures.

Sales, general, and administration costs itself accounts to 1.5 times revenue, which is an indication of the company’s inability to leverage its operating costs. I do not expect this situation to change anytime soon, as the company finds it difficult to expand without incurring significant selling costs.

Tilray has many clinical stage trials, and this might paint a positive outlook for the company’s growth at first. Let us first have a look at some of the clinical stage trials to gauge a measure of the projects Tilray is working on at the moment.

Source – Investor presentation

The problem here is that Tilray needs to invest significant amounts to carry on with these clinical trials, and the company is planning to test many more medicines in the next couple of years. Needless to say, Tilray wants more cash pumped into its business to continue these clinical trials and other capital investments.

On the other hand, Tilray is focused on inorganic growth strategies as well, and has already acquired stakes in three companies in quick succession. These multi-million dollar acquisitions are expected to add value to the firm in the long-run, but funding inorganic growth remains a worry for Tilray considering its financial health.

Recent acquisitions

Source – Crunchbase

Tilray has certainly relied on raising capital to meet expansion and inorganic growth plans, and this is set to continue in the foreseeable future as well. Further capital raises, whether it be debt or equity, will significantly affect the financial health of the company.

Tilray’s topline is close to $43 million, whereas its long-term debt stands at $420 million and is rising. Despite the rosy picture painted by the company management, I do not expect Tilray to reach profitability anytime soon. Even though there was some cash at the end 2018, this will soon be used for investments.

If Tilray doesn’t grow at a spectacular rate, which I don’t believe it would, the company would soon end up in trouble by not being able to service its debt repayments.

TLRY is not earning any positive free cash flow, and in fact free cash flow exceeded -100 million dollars in 2018. This came as a result of low operating cash flows and high capital expenditures.

Through 2023, Tilray has significant debt repayments coming up, and I clearly do not see a way for the company to gain enough momentum from a financial perspective to service these debt repayments.

Source – Form 10-K

From a valuation perspective, TLRY is trading at near-absurd levels even after the continuous decline of the share price since reaching an all-time high of $300.

At the current price to forward earnings of more than 1,000, I genuinely do not understand how an investor is supposed to benefit from the expected growth, as the growth number should better be some unimaginable number to justify the extreme level of valuation multiples.

Source – Morningstar

Conclusion

There is no doubt about the growth potential of the cannabis industry, but at the same time, investors need to remind themselves the fact that a sure sign of a growing industry does not mean that every company representing the industry will benefit from such growth.

Tilray is a stock to avoid without a doubt, and investors should research for alternative ways to play the expected growth of the cannabis industry. Tilray gives a lot of promises such as being the leader of a $150 billion industry, but these are all hypothetical estimates. Cannabis industry has a long way to go before being widely recognized and accepted by regulators around the world, and when being legalized, weed would be grown at very cheap prices all around the world, making it extremely difficult for companies to earn excess returns over their cost of capital for a prolonged period of time.

Tilray would need more capital infusions to continue with its growth plans, and this is only going to deteriorate the financial health of the company even further. With this in mind, I believe investors should avoid Tilray at the current market price.

That said, there’s a price at which every company looks attractive for investment.

What is this magic number for Tilray? Stay tuned as Dilly’s Research presents you with this number in our next article. We will use a two-stage discounted cash flow method to estimate a fair value for TLRY. As a reminder, the best way to stay tuned is by subscribing.