While it’s often narratives rather than numbers that cause stocks to swing in value, sometimes the most parsimonious way to summarize a company’s strengths and weaknesses is to focus on a key quantitative metric or two. Numbers never tell the whole story, but they can often give investors some pretty solid hints about what’s coming next.
One figure in particular is especially important to consider for investors who either hold or who are considering buying Tilray Brands (NASDAQ: TLRY) stock right now. Even if you’re not usually one for appreciating the numbers behind a stock, it’s worth paying attention to this one, so let’s dive in.
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Companies that can reliably make investments that generate higher returns than the costs associated with financing and making those investments tend to be better stocks to buy than companies that consistently make money-losing investments. That makes sense, because investors won’t be incentivized to contribute their capital by buying shares of the stock if they can see that the business previously did not get a good return on its capital. Nor will lenders be apt to offer loans at favorable interest rates if they see that prior loans were difficult to repay.
With that being said, it’s reasonable to expect that certain investments take a long time to pay off, losing money until after a critical threshold is reached and the return of the investment goes from the red to the black.
In Tilray’s case, investments are exactly the kinds of things you’d expect a multinational cannabis and alcohol business would need to operate. That includes everything from cultivation equipment and greenhouse facilities to distilling and manufacturing hardware, retail locations, vehicles, and distribution facilities, as well as investments in intangible assets like brands and intellectual property (IP). Most of that stuff is purchased outright, and then operated by employees to (ideally) produce value for shareholders when the products are sold.
Alas, Tilray’s trailing-12-month (TTM) return on invested capital (ROIC) is negative 5.5%. Its median ROIC over the last three years is even worse, at negative 9.4%. In this case, it is correct to say that such a return has has destroyed shareholder value rather than expanding it. And it’s a reason why you should be cautious with this stock.
There’s more than one explanation of why the company is struggling to generate more than its costs of capital. One key sign is its operating losses, which totaled $108.3 million in the TTM period.
In short, Tilray is spending so much money on its selling, general, and administrative (SG&A) expenses (which includes marketing) in an attempt to gain and retain market share that it isn’t profitable on an operational basis, despite the fact that it’s bringing in more revenue than the amount it had to spend to make that revenue directly, its cost of goods sold (COGS).
This chart makes the issue a bit clearer:
TLRY Revenue (TTM) data by YCharts
These are just a few common symptoms of a business that doesn’t have a competitive advantage that enables it to enjoy lower costs than the competition.
And it’s no surprise why. Primarily, Tilray competes in the recreational and medicinal marijuana markets of Canada, as well as the North American alcoholic beverage markets. All of those markets are saturated with competitors.
Without an edge like ownership of brands that customers are deeply loyal to and willing to pay more for, Tilray is limited to cutting prices or spending more on marketing and advertising to try to get its products in front of the public.
Don’t lose all hope for Tilray just yet.
In the next few years, its investments could indeed bear fruit and turn its ROIC positive. And with time, consumers could develop an affinity for its various brands, becoming loyal and allowing the company to ease back on its marketing spending without as much fear of losing market share. Major catalysts like marijuana legalization in the U.S., while seemingly forever-deferred, could one day massively expand its addressable market and shake up the equation too.
Furthermore, it isn’t under much financial pressure to become profitable, as favorable of a development as that would be for shareholders. As of its fiscal first quarter, it has $287.9 million in long-term debt and $280.1 million in cash, equivalents, and short-term investments. Its TTM cash outflow was just $82.2 million. So it can sustain its current pace of expansion into new markets for a while still.
Nonetheless, there’s not much reason to hold your breath for an immediate switch to increasing efficiency, at least not yet. If you buy this stock, expect to hold on to it for at least a few years before seeing a solid return, and know that you’re taking a larger-than-average risk.
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Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool recommends Tilray Brands. The Motley Fool has a disclosure policy.
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