I came across a press release this morning, an ‘Early Warning Report’ put out by Sundial ($SNDL) announcing that they’d disposed of 3% of their percentage holdings in Indiva ($NDVA). Boyo – the timing of that raise too (@$0.44) was on the same day $NDVA hit $0.68(!), an example of how weird things were back then.

I’d written about $SNDL’s entry into $NDVA back in February – and despite suggesting a Structure on $NDVA probably wasn’t worth the time, the piece essentially is a Structure. We saw an awfully thin cash position, little margin to speak of, and an intensity of ownership that clustered around 3 people and $SNDL.

Since $SNDL’s transformation from ‘Weed Co’. to Investment Bank – they’ve run up price on Valens ($VLNS), entered a nominal position with Clever Leaves ($CLVR), bought a retailer in Inner Spirit ($ISH), and most recently….walked into booze and bought Alcanna for paper (and yet again, at a hard premium).

$SNDL’s an odd outfit to be sure. A UK cultivation asset they’d bought for an undisclosed sum in 2019 (Bridge Farm) was unceremoniously dumped – not even lasting a year. That the buyer tendered and cancelled $SNDL shares is a tell that they wanted out, and to get at least something for their troubles. $SNDL’s transformation away from cannabis was in part (if not fully) enabled by the WSB effect of last January – and they hit the raise piñata more effectively than any other weed company I can think of.

Given it’s been a while since $SNDL’s buy into $NDVA – I thought I’d take a revisit to their financials and see how operations are doing. Their share price has be slightly more resilient than most in Canadian cannabis. $SNDL’s divestiture of their 3% began at those September’s highs – and continued until yesterday. One could probably wonder why $SNDL is paring position after only a 6 month hold: $SNDL describes the sell as for ‘investment purposes’ – which can translate to ‘profit taking’.

$SNDL’s holding is essentially at-the-money now (~=8.5MM shares at $0.44), and they maintain an ~=$11MM term loan with $NDVA. Let’s see what’s been going on at $NDVA since the start of the year.

To the financials!

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• Last 2 quarters have seen some big expansion in sales. Despite 2020 coming in for the year at $8MM, the first and second quarters of 2021 have been $6.2MM and $9.1MM respectively. Quite the ramp.
• Gross margin in Q1: 19%. Q2? 34% – I adjusted those for inventory impairment/write-down. This Q saw virtually nothing written down, the previous quarter it was $800k.
• Well, that’s a turnaround story unto itself.
• Despite this last quarter as being pretty much ‘record’ on every metric I can see, SG&A equals gross margin. Overall improvement though has been marked.
• We see the impact of $SNDL’s money on their finance charges, which wasn’t cheap either (sporting an effective rate of 17%), but a huge improvement. More below.
• Which begs the question of why $SNDL would choose to exit 23% of their holdings in $NDVA at this point. A hedge? Profit take? Perhaps they see no further upside in the near-term? Given $SNDL’s business model, I could see all three probable.
• Convertible holders have taken advantage of the share price accretion as well (nominal impact though. I’m sure they were happy to do so). Share count up from 110MM at beginning of year to 141MM.
• Interestingly – another tranche of convertibles (owned by Brett Wilson) sent out in early 2020, and laying around at a $0.25 conversion – haven’t yet been struck. Hmm. One might have thought him tempted to double his money – even if selling into market. At 10% interest rate, it’s one of the cheapest things on $NDVA’s balance sheet.
• Little segmentation. Looks like 93% of all sales were in edibles. The Craft Depot deal mentioned in our previous article doesn’t seem to have much traction. They attribute margin improvement to biomass input costs falling like a rock.
• Which – means these guys are extremely sensitive to input cost.
• Cash and A/R at $10MM. A/P at $7.5MM. Again, quite the flip from earlier this year.
• All said, they report a $1.4MM loss this quarter on $9MM in sales. QoQ – SG&A ramped at exactly the same rate as sales.
• And this – is $NDVA’s big problem. There appears to be little to no scalability in the business model.
• We’ve seen Auxly ($XLY) (among others) wrestle with this for the better part of 6 quarters as automation and learning curve were being baked into operations. Despite our ‘fast-twitch’ world of immediacy and instant gratification – it takes time to digest food, and many workouts to put on muscle.
• Some companies require wholesale change to enact efficiency improvements – as initial design was flawed, or management deferred capital spending to show better margin numbers and delayed an inevitable. This is another dial for you to watch – GoBlue’s examination of gross margin and its’ velocity over time is a fantastic measure in this regard.
• Tolling’s now irrelevant as business line – they shut it down in Q1. It’s probably a matter of time until only $VLNS is doing it. Those of you who have been in sector for a few years will recall how hard it came in, and now…..it’s virtually gone outside of micro/single batch runs. Sector capacity ran rampant, as we pointed out in September 2019……inadvertently ending up writing its’ eulogy.

Ok. Disclosure isn’t good overall, just par for the cannabis sector course.

I’ll point out their finance costs are steep, but not insurmountable. Note the difference YoY – as 2020’s includes that bridge financing I’ve referred to. Recall for 2020, the costs were for half the amount of indebtedness 2021(!):

This quarter’s finance costs reveal that bridge they took last summer was rolled off and replaced by $SNDL’s cash. Yet, that cash wasn’t cheap either as Note 13 reveals (17% effective interest rate). Despite this – one might suggest (accurately), that $SNDL ‘saved’ $NDVA. All of the ‘loans payable’ prior to February 23rd relate to that bridge: the effective annual interest rate on it comes in around 34%:

The reason I point this out – high cost loans are one of the most reliable indicators of financial distress I know of. You’re probably thinking to yourself that might not be not the most insightful observation I’ve ever made – but. I mean it as to indicate that a ‘terminal condition’ exists at a company. That something will come to a head. And soon.

While bankruptcy or insolvency may or may not be the result – by ‘terminal’ I mean that the organization is heading to some sort of serious catalyst. That ‘catalyst’ could an externally enforced reorganization, asset stripping, creditor rearrangements (think MedMen/iAnthus/Zenabis) – any and all of these will result in significant value being stripped from common shareholders.

Keep your eyes on the credit costs of the companies you watch/own. If I’ve a lazy streak – it’s that I price raises and debt deals to establish a 3rd party’s valuation of risk in a company. Subscribers will know of many deals that I’ve priced out – and noting where the expensive ones are coming in is the single best tell of serious financial distress I know of.

Sure – there might be a good GM uptick, or a batch of new SKUs or some sort of operationalizing imminent – but. Money coming in hot also means the creditors will take those assets if every single cylinder doesn’t fire, and common shareholders will be paying for it. In the case of $NDVA – it was the ‘white-knight’ of $SNDL – who essentially traded over a company by being able to source cheaper them funds than market – in exchange for a whack of $NDVA on the cheap.

<In that Medipharm ($LABS) example – it all began with a convertible debenture demand call back in March of 2020. If one had exited their position on that event, they would have retained more than a $1 in share value than where it is now. The point I’m making: re-evaluate your investing thesis often. If a core assumption of it changes, be ready to change too. Blue’s emphasized this – I can’t emphasize it enough. IMO – far too much is made of ‘weak hands’ and the assorted glib sell-side phrase implants>.

According to $VLNS latest financials – I impute LYF (their edible segment) to have contributed ~=$1.5MM in their last quarter. With Dynaleo/Dosecann out there – it’s going to be a competitive field. If anything, $NDVA is really in front of the crowd at the moment.

Next financials, I’d look to see if there was any channel stuffing/price cutting made recently – if sales don’t remain flat to up – it might signal the ebb/flow or provincial ordering, and not a durable uptick. I’d also keep an eye on that gross margin number. Perhaps they did a deal on some cheap outdoor product to get feedstock – and if there’s something that bodes well for this place, its’ that they should be able to source cheap biomass for awhile. Unlike the vape and BHO products – edibles can go as downmarket as need be in sourcing molecules.

I’ll circle back to these guys, as their current run rate shows some heft. If there’s a way they can get some sort of scalability in place, it bodes even better.

Personally, I am looking for exposure to the extract/edible segment. Despite it being an awful place to be at the moment, I’m trying to spot who the natural consolidator/king seed is that’s going to emerge. $VLNS has a passel of things going on operationally (they mention 7x in their last statements about getting away from tolling), building out LYF, and transitioning into a ‘manufacturing company’.

I won’t be touching $NDVA for now. The father/son dynamic is unattractive on its’ face to me, as is it being used as an asset play by $SNDL. Yet with sales showing such a ramp, one wonders if they can’t find a low-cost-on-every-shelf place for them into the future. Getting to scale is the next hurdle $NDVA needs to do towards building out a functional business model.

The only ‘extractor’ I own currently is Hollister Bio ($HOLL), a rangebound mutt I’m holding short term as a brand play on an Arizona recreational catalyst.

The preceding is the opinion of the author, and is in no way intended to be a recommendation to buy or sell any security or derivative. The author holds no position in any of the companies mentioned.