The stock market is a wild place that is frequently incoherent in its approach to pricing companies as sentiment towards sectors and component companies ebbs and flows like the waves of the sea. When times are good, valuations run high. When they turn bad, valuations can sometimes run at a discount to intrinsic value.
Panic? Lack of interest by investors? Overzealous discounting of future earning power? Whatever the cause, it always fascinating to discover stocks like TILT Holdings (OTCQB:TLLTF), which currently trades at a forward 1-year EV/S ratio of 0.98 and a price/book value of 0.22. Yes, while year-over-year revenue growth might still be negative, it is hard to justify the material discount to book value TILT currently trades at. The market is essentially valuing line items on the company’s balance sheet as nearly worthless. This will prove to be naive if the current inhibitory regulatory environment changes on the back of a flip in power following the US presidential elections.
A company like TILT, a fringe stock by all measures, trading on the OTC markets in a collapsed sector largely out of the investing mainstream was always going to be mispriced. With very little analyst coverage, it is easy for any such mispricing to go unnoticed. This is especially heightened by the negative sentiment towards the sector following the bursting of the bubble that formed in the onset of Canada’s legalization of recreational cannabis.
I last covered TILT in the first week of February 2020, where I argued that it was undervalued and had been unfairly lumped with the other laggards of the collapsed sector. This was before the pandemic fully afflicted the stock market and impacted sales of cannabis at brick-and-mortar locations in the USA. The pandemic, which initially resulted in “pantry stocking” or panic buying of cannabis by consumers, eventually morphed into muted demand as operators chose to conserve capital by maintaining lower inventory levels.
TILT’s Financials In the COVID-19 Era
TILT last reported earnings for its second quarter 2020 ending June. The company realized revenue of $38.6 million, a year-over-year decrease of 1.1%. While negative growth is disappointing, this compares favourably with its industry peers who realised double-digit declines in their most recent earnings reports.
Further, with a net loss of $9 million versus $48.90 million realised in the previous year, the company is clearly operating more efficiently.
The brightest spot in the company’s earnings result is the forming trend of tightening operational losses. The fourth quarter of 2019 saw negative operational cash flow of $15.50 million, but this went positive in the subsequent quarter at $4.28 million. The most recent quarter saw this rise further to $6 million, a quarter-over-quarter increase of 40%. This had the direct effect of marginally increasing cash and equivalents 25% to $10.5 million.
The company’s management, during its earnings call for the last quarter, signalled a shift in strategy from stabilization to identifying, unlocking and accelerating growth drivers across the portfolio of businesses. From a base of positive operating cash flow, this should help drive incremental gains in revenue and earn the company more hard cash on its balance sheet. This outcome represents the single best case for TILT.
Upwards Catalysts And Risk
The sector has suffered greatly as cannabis companies, previously valued on the back of the vast global opportunities that lay in front of them, have continued to burn a significant amount of cash as their revenues flatlined or went into reverse. TILT needs to be able to show the market that it has bucked this trend. If TILT can maintain the forming trend from the last two quarters, which saw it generate a combined operating cash flow of $10.20 million, the company will be able to improve the investor sentiment it receives.
The pace and extent to which this happens will determine how efficiently TILT will service its total debt of $65.20 million. A tepid upward trend or a reversal in its positive operating leverage will see the company having to sell shares or take on even more debt. The former’s dilution will drive its shares further into obscurity, while the later will overextend the company’s balance sheet and open up the spectre of bankruptcy.
The Baby Is Still Being Thrown Out With The Bathwater
Cannabis investments have proven to be a disappointment for most, and there is no certainty that the current inhibitory environment will change in the medium term. This barrier will put a permanent ceiling on revenue and any type of operating leverage TILT can hope to achieve in the coming quarters.
Assuming TILT’s now two quarters of operating cash flow remains constant, a rare trend in a sector experiencing structural decline, the company’s current market capitalisation will prove to be myopic.
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.