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Why Canopy Growth's Losses Continue Outpacing Sales

By Cory Renauer – Jun 23, 2019 at 10:07AM

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Can this titanic-sized cannabis producer turn its ship around before it's too late?

Canopy Growth (CGC -7.01%) disappointed investors again with a dismal quarterly earnings report. Canopy is the world's largest cannabis producer and has a leading share of a Canadian market that opened up to every adult in the country last October.

After reporting a CA$157 million loss during the last three months of 2018, Canopy Growth blamed kinks in the supply chain. During the first three months of 2019, operating losses increased by 54%, making it clear that there's a much larger problem.

Stacks of banknotes under some cannabis.

Image source: Getty Images.

Some investors who don't know much about cannabis are still scratching their heads trying to understand why Canopy Growth and its peers can't make any money selling pot. You don't need a psychedelic experience to understand why Canadian marijuana producers keep reporting increasing losses, but there are two important things investors need to know about cannabis.

1. It grows like a weed 

Try to imagine a world where you can produce gallons of 18-year-old single-malt scotch in a tent the size of a small closet a few times each year with just a few hundred dollars' worth of equipment to get started. How tough do you think it would be to sell bottles of Red Label Johnny Walker for $25 on such a bizarre planet?

In the real world, making your own alcoholic beverages is generally more expensive than just buying something mass-produced. The same can be said of most packaged-food products. But not cannabis. Retired couples with a little extra room in their empty nest can quietly produce enough top-quality cannabis to supply their entire neighborhood, and that includes edibles, concentrates, and vaporizer cartridges.

outdoor greenhouse growing marijuana.

Image source: Getty Images.

2. It does not scale well

Canopy Growth and its peers convinced investors that huge expensive greenhouses could produce mountains of top-quality cannabis at a price so low it would quickly marginalize the illicit market. Canopy Growth investors are learning the hard way that this isn't the case.

People with a little extra space at home can quietly produce enough top-quality cannabis to supply their entire neighborhood with hardly any overhead. If they're willing to go an extra step to process their dry flower into edibles, concentrates, and vaporizer cartridges, they can even supply a larger audience by running one of the dozens of illegal but tolerated mail-order marijuana services that compete with Canopy.

A hobbyist who spends five minutes each day tending a few plants can produce more than 300 grams of dry flower from a single plant using high-powered lights, or average around 150 grams per plant with cheap lights. You'd probably expect expensive state-of-the-art cultivation facilities to produce far more dry flower per plant, but it's the other way around. During the year ended in March, the average Canopy Growth plant yielded just 86 grams.

Cannabis plants begin flowering once they begin receiving total darkness for at least 12 hours a day. That means Canadian greenhouses must completely cover all their windows during a portion of these long summer days. Just one broken pane of glass during the six- to eight-week flowering stage can ruin an entire crop unless a producer is willing to make a trade-off and use auto-flowering seeds. Autoflower product is generally less desirable, and lower-yielding than flower grown from regular seeds, but their flowering process isn't affected by long days and short nights. 

Dollar sign shadow cast across pot leaves.

Image source: Getty Images.

Hope abroad?

Canopy Growth finished March sitting on CA$4.5 billion in cash and securities that won't carry the company to profitability unless international sales get up off the ground. Although Canopy has invested heavily to develop an international footprint, sales outside Canada reached just CA$1.8 million during the first three months of 2019, which was less than reported in the previous quarter. 

Canopy Growth isn't allowed to operate in the U.S. because the company wanted to raise more money through a New York Stock Exchange listing than it could on stock exchanges currently willing to list U.S.-based cannabis companies. Canopy Growth is ready to enter the market after spending $300 million for the right to buy Acreage Holdings (ACRGF) for $3.4 billion if the federal government legalizes cannabis.

If the U.S. Drug Enforcement Agency reschedules marijuana, this could be a huge disaster for Canopy Growth. That's because legalization would push cannabis into the Food and Drug Administration's purview. There's a chance the FDA would give the psychoactive substance the same lax treatment it offers herbal supplements, but I wouldn't bet on it. A new series of regulatory hoops to jump through that raise expenses for producers and drive sales back to the illicit market seems far more likely. 

One way or another, Canopy Growth's losses probably won't stop before they chew all the way through the company's giant cash cushion. 

Cory Renauer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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