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5 Things to Love About Canopy Growth Corp.'s Third-Quarter Results, and 1 Figure to Hate

By Sean Williams - Feb 16, 2018 at 10:01AM

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It's easy to see why Canopy is the world's most valuable pot stock. But understand that it's far from perfect.

The marijuana industry is growing at a blistering pace, and investors can't help but take note. ArcView, a leading cannabis research firm, anticipates that North American legal weed sales could grow by 26% a year through 2021, hitting as much as $22 billion annually in the process. This sales growth is a big reason why pot stocks have doubled or tripled in value over the past year.

But it's not the U.S. industry that's leading the charge. The United States' restrictive Schedule I classification for weed, along with Attorney General Jeff Sessions leading a crusade against the pot industry, is making life exceptionally difficult for U.S.-focused companies. Investors have instead turned their attention to Canada, which has been a blueprint for success when it comes to marijuana.

Cannabis buds next to a piece of paper that says yes, atop miniature Canadian flags.

Image source: Getty Images.

Canada legalized medicinal cannabis back in 2001, and it appears to be on the verge of green-lighting recreational pot for adult use by July 2018. Parliament looks to have all the votes it needs in place, and a two-year tax-sharing agreement is on the books between the federal government and provinces. If legalized, recreational weed could be a means to $5 billion in added annual sales.

Canopy Growth dazzles once again

Perhaps no company stands to benefit more than Canopy Growth Corp. (CGC 4.72%), the largest pot stock by market cap. This "green giant" reported its fiscal third-quarter operating results this past Wednesday, and in many respects, remains on track with regard to meeting or exceeding investors' expectations. Though it reported a 123% increase in year-over-year sales, along with an adjusted profit, inclusive of a one-time gain, the following five aspects of its earnings report are what investors should really love. 

1. Market-leading patient reach

To begin with, investors are bound to appreciate the immense reach that Canopy Growth has in the medical market. Even though recreational weed would likely halt growth on the medical side of the equation, registered patients are still vital in the interim for generating sales and reducing the cash burn tied to capacity expansion.

Canopy Growth ended its most recent quarter with 69,000 active registered patents, which was more than double the 29,000 active registered patients it had in the year-ago quarter. This is a testament to the company's distribution reach, its acquisitions, and its market-leading production brand, Tweed.

An indoor commercial cannabis grow farm, with marijuana plants in a greenhouse with electric fans blowing on them.

Image source: Getty Images.

2. Millions of square feet in capacity expansion

Wall Street and retail investors should also be impressed with the magnitude of expansion the company is undertaking. Aside from the 665,000 square feet it currently boasts for growing across seven facilities, it's working on 3.7 million square feet of greenhouse projects -- yes, 3.7 million square feet – in British Columbia.

In the third quarter, Canopy Growth only harvested around 8,000 kilograms of cannabis, but that was 51% more than the prior-year period, and this figure is expected to soar many times over if and when recreational pot is legalized. By some estimates, the company could control as much as 15% of the recreational market in Canada.

3. Improved product mix is boosting average selling prices

Interestingly enough, it wasn't the 123% sales growth that stood out to this investor, but the 13% year-over-year improvement in average selling price per gram to $6.65 (CA$8.30) that's much more impressive. Even though demand could be responsible for driving up prices, that's not the main reason why Canopy Growth has recognized a juicier price point for its products. The answer lies with its product mix.

Digging into the details, the company sold 2,132 liters, or 262 kilogram-equivalents, of cannabis oils and softgel capsules during the fiscal third quarter. That's an increase of 84% from the prior-year period, and it pushed the total product revenue generated by oils and capsules to 23% from 13% year over year. Oils and softgel capsules have a considerably higher price point and better margin than dried cannabis, so this shift can only be viewed as good news for investors.

A potted cannabis plant next to a bottle of wine.

Image source: Getty Images.

4. Expansive distribution channels and partnerships

It's also impressive how Canopy Growth has been able to improve its visibility through partnerships and distribution channels. As an example, the company points out in its quarterly report that it became the first Canadian grower to sign separate memorandum of understanding cannabis supply agreements with the provinces of New Brunswick and Newfoundland and Labrador.

Furthermore, it entered a strategic relationship with global spirits giant Constellation Brands (STZ 2.57%) during the quarter. The $191 million deal wherein Corona maker Constellation bought a 9.9% stake in Canopy Growth should give rise to collaborative new product development, as well as the potential for new distribution channels for Canopy Growth in the future.

5. Over $320 million in cash and cash equivalents on hand

Finally, it's worth pointing out that Canopy Growth has a whole lot of cash on its books. Having ended the quarter with around $190 million in cash and cash equivalents, the company has pushed to well over $320 million ($CA400 million) in cash and cash equivalents post-quarter, thanks to bought-deal offerings. With such a robust amount of cash on hand, it should have no trouble arranging the financing to complete its multiple capacity expansion projects in British Columbia.

An annoyed investor reading news on his laptop.

Image source: Getty Images.

Now this won't make investors very happy

However, Canopy Growth's quarterly report wasn't perfect. In fact, there was one glaring statistic that I, and I believe shareholders, could truly despise. Namely, the company's ballooning outstanding share count.

On an adjusted basis, it earned about $0.01 per share in the latest quarter. Mind you, this removes the $7.05 million (CA$8.8 million) it gained from the disposal of its Agripharm business from the equation, giving it $1.76 million (CA$2.2 million) in income for the quarter. But this figure was divided into 194.7 million shares, which is what Canopy had outstanding as of its most recently ended quarter. By comparison, it had only around 77 million shares outstanding at the end of 2016. Without this dilution, it would have earned closer to $0.023 (CA$0.03) this past quarter. In other words, the company has to more than double what it would have earned in profit in fiscal 2016 to earn the same amount in 2018 because of share dilution.

Where is this dilution coming from, you wonder? It's a function of the bought-deal offerings that pot stocks are so fond of in Canada. Though pot stocks have had no trouble raising cash, these convertible debt offerings, warrants, and options should balloon outstanding share counts in the years to come. That could mean even with the sales needle spiking, profits on a per-share basis will go virtually nowhere.

Dilution is a potentially serious problem for marijuana stock investors, and Canopy Growth's shareholders would be wise to factor in the potential for dilution when assessing the company for investment.

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