Shares of cannabis producer Tilray (NASDAQ:TLRY) have been building solid gains in recent weeks, but investors should still approach this volatile stock with caution.

The price of the Canadian cannabis company’s stock has more than quadrupled since bottoming at $2.47 a share on March 18. However, TLRY stock is still trading at less than half the $21.36 price per share it was at in mid-January. And the share price remains well off its 52-week high of $51.03. While the stock has been trending in the right direction recently, signs point to continued volatility for the company, and its shareholders, over the near term.

Striving for Profitability

Like its competitors, Tilray is striving to become profitable in what is still a burgeoning and unproven industry for legal recreational cannabis. The Nanaimo, British Columbia-based company has been closing facilities and restructuring its workforce in an effort to improve its balance sheet. Tilray recently announced that it hopes to achieve $5.5 million in net annualized savings by shuttering a 37,000-square-foot cannabis cultivation and processing facility. The company announced in February that it would sack 10% of its 1,500-person workforce.

While analysts have been nodding in approval regarding the restructuring, it remains to be seen if Tilray’s efforts will be enough to move it out of the red and into the black. The company’s first quarter results offered some encouraging signs, but disappointed with a net loss of $184.1 million and an adjusted EBITDA loss of $19.7 million. Analysts that follow the company had been expecting a net loss of $49.1 million and an EBITDA loss of $26.6 million. While Tilray CEO Brendan Kennedy promised that the cannabis producer would achieve positive EBITDA by the fourth quarter of this year, several analysts downgraded their rating on TLRY stock to sell following the results.

Still, it is worth pointing out that Tilray’s net revenue rose 126% to $47.1 million in the first quarter compared with the same period last year, and was up 11% from the previous fourth quarter. With cannabis deemed an “essential service” in most of the Canadian markets in which it operates, Tilray said it has seen increased demand for the recreational drug since lock downs prompted by the novel coronavirus pandemic took hold in mid-March. And, in another encouraging sign, sales of medical cannabis in Europe exceeded those in Canada for the first time during the most recent quarter.

Overcoming the Black Market

The problems plaguing Tilray and other cannabis producers go beyond the effective management of a company. When Canada’s federal government legalized cannabis for recreational use in October 2018, Prime Minister Justin Trudeau and his cabinet confidently forecast billions of dollars in new tax revenue — money that could be used to fund everything from highway repairs to new schools. Tilray and peers like Canopy Growth (NYSE:CGC) and Aurora Cannabis (NYSE:ACB) suddenly became hot plays in an emerging new industry. But going on two years later, the legal market for cannabis has failed to take off.

Data from federal agency Statistics Canada shows that, to date, the legal market for recreational cannabis has only supplanted 14% of the black market. The vast majority of people still purchase cannabis on the black market or grow their own supply . The main reason is price (and taxes). The average price of legal cannabis sold in Canada was $10.23 CAD ($7.58) a gram at the end of 2019, compared to $5.59 CAD per gram on the illegal market, according to Statistics Canada. And, taxes levied on legal cannabis amount to $1 CAD a gram — 25 cents CAD for the federal government in Ottawa and 75 cents CAD for the respective provincial tax coffers. There are no taxes charged on the black market.

Efforts by Tilray and other cannabis producers to get licenses to export product to Europe and the U.S. for medical and recreational use have been largely hit-and-miss. Industry watchers say that for companies such as Tilray to gain ground and achieve profitability, they will need to close the price gap with the illegal cannabis market and make inroads in foreign markets. Neither hurdle looks like it can be jumped in the near term. And the entire legal cannabis sector has been under increasing pressure lately. Canopy Growth on May 29 reported a $1.3 billion quarterly loss — news that sent the share prices of most cannabis companies, including TLRY stock, sharply lower.

Bottom Line on TLRY Stock

In time, the legal cannabis market is likely to mature and grow. But in the near term, volatility should be expected. For this reason, investors who put money in TLRY stock do so at their own risk.

Among the dozen analysts who have 12-month price forecasts for TLRY stock, the median price target is $8.50 per share, with a high estimate of $20 a share and a low estimate of $6 per share. The median estimate represents a more-than-15% decrease from the current price of about $10 a share. The consensus rating of analysts is to hold TLRY stock, though a growing number have been switching their rating to sell.

Given the ongoing volatility of not only TLRY stock, but the cannabis sector as a whole, investors should approach Tilray shares with caution.

While the prospect of a new industry and emerging companies may seem attractive, there is no indication that the legal market for recreational cannabis will achieve its promise anytime soon. Investors with an appetite for risk should look for a low entry point on TLRY stock and temper their expectations for big returns.

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