SNDL(NASDAQ: SNDL) has been transforming its business in recent years. It has gone from being solely a marijuana producer to also running pot shops and even getting into the alcohol business. As a result of those moves, revenue has been soaring, and the company's bottom line has also improved. Most recently, the company also hit a significant milestone, by reporting positive free cash flow.
It's a huge accomplishment in an industry where many companies normally burn cash. But SNDL isn't without its risks, and there are still challenges ahead. Has the stock become a better buy after its latest quarter, and is it worth investing in today, or should investors remain cautious on SNDL?
The company's cash position has improved
Last week, SNDL reported its third-quarter results. The big highlight for SNDL was that it posted positive free cash flow totaling 16.5 million Canadian dollars ($12 million). That was a huge turnaround from the negative CA$67.1 million in free cash it reported a year ago.
Chief Executive Officer Zach George called the company's positive free cash flow a "pivotal milestone, reflecting our team's commitment to operational and financial excellence." Strong free cash flow is something SNDL remains committed to generating as it works on improving its margins and strengthening its bottom line.
How SNDL achieved positive free cash flow
Free cash flow isn't a standard calculation as per generally accepted accounting principles (GAAP), which means that how companies calculate the metric can vary. Many companies calculate free cash flow by taking operating cash flow and deducting payouts for property, plant, and equipment. But that's not how SNDL calculates it. It looks at the overall change in cash and cash equivalents and reduces the amount it spent on the repurchase of common shares.
For example, a year ago, it said its free cash was a negative CA$67.1 million, but that was largely due to the CA$60.7 million it spent on investments. While there's no right way or wrong way to calculate a non-GAAP number, many investors would say that technically SNDL reported free cash flow in the prior-year period as well. Its operating cash flow in the year-ago quarter totaled CA$8.6 million, and spending on plant, property, and equipment was only CA$2.1 million.
In the end, what matters is that the company generated more cash flow. Operating cash of CA$27.5 million this past quarter was more than three times the CA$8.6 million SNDL reported a year ago. A big reason for that was that its net loss of CA$21.8 million wasn't as deep as the CA$98.8 million loss it incurred a year ago (although that was largely due to impairment charges). It also brought in more than CA$3.2 million in proceeds from the settlement of securities. Changes in working capital were also a big factor, generating CA$13 million in cash versus just CA$1.2 million a year ago.
Why investors should remain cautious
SNDL posted free cash flow last quarter, but it may not be sustainable. The reason is that working capital can fluctuate from one period to another, and the company's gross margins weren't terribly impressive. Despite reporting more net revenue this quarter (CA$237.6 million versus CA$230.5 million a year ago), the company reported a lower gross margin -- CA$48.6 million versus CA$50.3 million. Impairment charges played a role in that, but if SNDL is to have any hope of turning a profit and generating free cash flow on a continuing basis, its margins will need to improve significantly.
What's more concerning is that the business which generated the most in gross margin for the company, SNDL's liquor retail segment, reported slightly less in revenue than it did a year ago. If SNDL's growth primarily comes from its cannabis segments, which have the worst margins, the net effect is that the company may report declining cash flow in the future.
SNDL isn't a buy, despite achieving this "milestone"
Although it sounded great that SNDL reported positive free cash flow this past quarter, there's not enough of a reason to believe that this is indicative of a stronger, more consistent financial performance in the future for the company. With modest gross margins and growth only coming from its cannabis operations of late, SNDL hasn't suddenly become a much better stock to invest in. There's still plenty of risk with the stock, and for most investors, it's better off to steer clear of SNDL entirely and pursue other growth stocks instead.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends SNDL. The Motley Fool has a disclosure policy.
