Lack of cash flow is a big problem in the cannabis industry. Even though some marijuana growers can generate high sales numbers, many of them are unprofitable and burn money. For investors, this is problematic as it often means stock offerings, dilution, and falling stock prices.
Cannabis company based in Canada Producers of sundials (NASDAQ: SNDL) lends money to a marijuana grower at a high interest rate that could generate millions of additional income for his business over the next several years. This could turn out to be a great move for the company – but is this stock of memes still too risky to invest in right now?
Sundial increases loan to Indiva
In February, Sundial invested C $ 22 million in an edible cannabis producer Indiva. Half of that amount was an equity investment, while the other half was a term loan, in which Indiva would pay an interest rate of 9%.
This month, Indiva announced an amendment to this agreement. Sundial provided an additional C $ 8.5 million to the company, and now the total capital balance (which includes deferred interest charges) it owes stands at $ 19.75 million. Canadian.
Some things stand out from the original agreement. The first is that now the interest rate is 15%, which is significantly higher than the previous 9% that the sundial would have collected.
Another interesting change is that previously Indiva had the option of paying only half of the monthly interest (the other half could be payable in arrears – hence the deferred interest charge on the principal balance). Under the new agreement, this option does not exist and “100% of accrued interest is payable in cash and accrued on a monthly basis”.
Lots of extra cash flow, but it’s not risk free money
This translates into a monthly interest income of approximately CA $ 246,899 (US $ 197,519). Over the term of the loan (which expires in February 2024), Sundial will have received 1.375 times its principal amount, which amounts to C $ 7.4 million ($ 5.9 million) in additional revenue. This is a big boost for a company that has spent CAD 137 million in the past 12 months. While this alone will not be enough to offset the negative cash flow, it is a solid way for Sundial to strengthen its finances.
The danger, of course, is that it depends on how strong Indiva’s activity is. If the business is struggling and cannot make these payments (it has not made a profit or generated positive cash flow from its operations in the past 12 months), then some (or all) of these interest income could end up being written off as uncollectible. To me, this sounds like the equivalent of a junk bond – a high yielding interest payment that comes with significant risk. After all, if Indiva’s finances were on a solid footing, it’s hard to imagine that she couldn’t have found a way to raise money at a much lower interest rate.
However, I always applaud Sundial for looking at options to get the most out of its money and diversify its operations and cash flow.
Does that make Sundial a better buy?
This move, in essence, is still quite small for Sundial. As of August 9, the company had an unrestricted cash balance of C $ 760 million, and these additional interest payments, alone, will not be a game-changer for the company.
But what I’m going to watch out for is if Sundial will make any similar moves in the future. This year, the company formed a joint venture with private equity firm SAF Group called SunStream, which is looking for investment opportunities in the marijuana industry. As of July, Sundial had contributed C $ 538 million to the company.
The company has also made great strides in recent times, acquiring cannabis retail company Inner Spirit Holdings and Alcanna, which operates 171 liquor stores in Canada (this deal was just announced last week and is not expected to be finalized until the end of the year or early 2021).
With so many changes on the sundial this year and the risk of dilution underway here, the safest bet for investors is to simply take a wait-and-see approach for now.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.