The marijuana industry is growing like a weed, and Canopy Growth (NYSE:CGC), the largest marijuana stock by market cap (by a mile), is leading that charge.
According to a recently released co-authored report from Arcview Market Research and BDS Analytics, global cannabis sales are slated to rise by 38% to $16.9 billion in 2019, and eventually top $31 billion by 2022. Considering that Canopy Growth is cash-rich following a significant equity investment from Constellation Brands (NYSE:STZ); is unquestionably a top-two grower by annual peak production; and is a leader in multichannel sales, logistics, and branding, it's no wonder that all eyes are on the company's third-quarter earnings results.
On Thursday, Feb. 14, long after the stock market had closed, Canopy Growth reported its much-anticipated third-quarter operating results. Here are the 12 pertinent facts you'll want to know.
1. Net sales surged 283% (but technically missed the mark)
The first figure investors are bound to drool over is Canopy Growth's net sales of 83 million Canadian dollars, which represents a 283% increase from the year-ago quarter, when it generated CA$21.7 million in net sales. With Canopy's fiscal third quarter ending on Dec. 31, 2018, it included about 2.5 months of post-legalization recreational weed sales, and it clearly shows in the company's sales figures.
Yet, for what it's worth, Canopy's top-line number actually missed the mark, with six Wall Street analysts looking for a consensus of CA$85 million. It just goes to show that, with this industry being so new, it's as much of a guessing game for Wall Street as it is for investors.
2. Canopy is all about those recreational weed sales
Whereas we witnessed Aurora Cannabis report more medical marijuana sales than recreational cannabis revenue earlier this week, it wasn't even close for Canopy Growth. During the third quarter, medical marijuana sales totaled CA$18.6 million, down from CA$20.3 million in the year-ago quarter, when medical pot sales were all that were legal.
Comparatively, Canopy recorded CA$71.6 million in recreational weed revenue, of which CA$11.5 million was business to consumer, and CA$60.1 million was considered business to business. Also, if you're wondering why these sales figures add up to more than the reported CA$83 million in net sales above, it's because these are gross sales, prior to accounting for excise taxes.
3. Inventory rose substantially
Aurora Cannabis is likely to lead all growers in peak annual production, with yours truly forecasting up to 700,000 kilograms a year in output. But Canopy Growth is liable to come in a close second, with north of 500,000 kilos of annual yield. A substantial increase in licensed cultivation capacity certainly helped the company grow its inventory during the third quarter.
Having ended the previous fiscal year (March 31, 2018) with CA$101.6 million in inventory -- this includes finished goods, work-in-process, merchandise and devices, and supplies and consumables -- Canopy completed Q3 2019 with CA$185 million in inventory. A roughly CA$49 million increase in value assigned to work-in-process, as well as a CA$30 million jump in supplies and consumables, suggests that Canopy's output, and product diversity, are growing.
4. Margins declined considerably due to the excise tax
What isn't growing is the company's gross margin. Despite sales growth of 283%, cost of goods sold soared by 560% to CA$64.8 million. When combined with CA$14.7 million in excise tax costs on recreational goods sold, Canopy ended the quarter with a measly gross margin of CA$18.3 million on CA$97.7 million in gross revenue (CA$83 million net). On a year-over-year basis, gross margin plummeted from 55% to just 19%. Yuck!
5. The fair-value adjustment door swings both ways
Recently, International Financial Reporting Standards (IFRS) accounting has been mostly a blessing for cannabis growers. IFRS accounting, which treats marijuana as an agricultural commodity, requires that growers revalue their crops constantly, based on the stage of the growth cycle they're in. Growers also need to estimate the cost to sell their crops, often well before they're sold. Needless to say, this leads to some very legal, yet nevertheless wild, swings in gross margin.
In Canopy's third quarter, investors learned that these swings aren't always positive. After fair-value adjustments for biological assets (i.e., cannabis plants) and unrealized gains or changes in fair value were applied, the company's gross margin deteriorated by another CA$5.8 million, to CA$12.5 million.
6. Operating losses were huge
If you thought there was any chance of an old-fashioned operating profit here, think again. General and administrative costs more than quadrupled to CA$46.1 million, sales and marketing expenses came close to quintupling at CA$44.9 million, and the always-popular share-based compensation (I say that with sarcasm) rose to CA$40.1 million from CA$9 million in the year-ago quarter.
All told, Canopy's operating expenses ballooned to CA$169.7 million, leading to a loss from operations of CA$157.2 million. Through the first nine months of fiscal 2019, Canopy's operating losses are up to a staggering CA$402.6 million.
7. On the other hand, one-time gains were massive
However, it wasn't a complete loss, if you like one-time benefits and fair-value adjustments elsewhere on a company's income statement. Changes in fair value on financial assets designated as fair value through profit or loss (FVTPL), and changes in fair value on financial liabilities designated as FVTPL, led to a combined one-time gain of more than CA$221 million. In combination with other one-time adjustments, Canopy claimed CA$235.2 million in "other" income this quarter.
For its bottom line, Canopy Growth lost $0.38 per share on an adjusted basis. But, inclusive of this comprehensive income, it earned $0.22 per share.
8. The company's accumulated deficit is an eyesore
Though it's not a figure that most investors will focus on much, since it's backward-looking and Wall Street is forward-looking, Canopy's accumulated deficit is soaring. A company's accumulated deficit is simply its aggregate losses since inception. Even with the benefit of Canopy's "other" income during Q3 2019, its accumulated deficit still stands at CA$441.5 million, up from CA$91.6 million when its fiscal year began on April 1. That's a bit worrisome for investors.
9. But it's not as scary as rising goodwill
Arguably, though, it's nowhere near as scary as the company's ballooning goodwill associated with its acquisitions.
In its simplest form, goodwill is simply a measure of the premium one company pays for another that's above and beyond the tangible assets it's acquired. Goodwill isn't necessarily a bad thing, if it can be recouped with other intangible factors, cost synergies, or future growth prospects. But in the company's SEDAR filing in Canada, Canopy outlines that nearly all of its recent transactions have been loaded with goodwill. At last check, its goodwill accounts for CA$1.82 billion of total assets. It's a bit early to tell how much of this premium will be recouped by Canopy, but substantial future writedowns aren't out of the question.
10. Canopy is rolling in the dough
On the bright side, no marijuana stock is better financed than Canopy. Following the completion of an equity investment from Constellation Brands, which gave Constellation a 37% equity stake in the company in return for $4 billion in cash, Canopy Growth now has CA$4.12 billion in cash to go along with just shy of CA$800 million in marketable securities. There's virtually no concern about funding issues with this company, and investors should look for Canopy to remain aggressive on the acquisition front throughout 2019.
11. Holy dilution, Batman
Of course, there's a downside to raising capital with pot stocks, and that's the fact that they love to issue stock like it's going out of style. Between the Constellation equity investment, a number of acquisitions that had a large share-based component, share-based compensation, and bought-deal offerings that were designed to raise capital, Canopy's outstanding share count rose by 75% year over year to 334.7 million shares as of Dec. 31, 2018.
Yes, there is the positive that Canopy is putting this cash to work in its business via acquisitions. But at the same time, more shares outstanding will make it that much harder for the company to produce a meaningful per-share profit.
12. More share-based dilution awaits
Last, but not least, you can unfortunately count on more share-based dilution in the future. The company ended the most recent quarter with 107.9 million warrants outstanding, as well as 31.6 million options outstanding. If and when these assets are exercised, Canopy's share count is going to rise. In other words, it's going to be very difficult for fundamentally focused investors to get behind this stock.
Just a few weeks ago, I opined that it simply wasn't reasonable to assign what was then a $17 billion market cap to Canopy Growth, given the expectation of ongoing losses and the numerous uncertainties that lie ahead for an untested industry. Even with the valuation having tapered slightly to $16 billion, my thesis hasn't changed. Buyers of this top-tier marijuana stock are possibly playing with fire at this valuation.