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Canopy Growth Just Confirmed What We've Long Suspected

By Sean Williams - Jul 17, 2019 at 6:36AM

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Canopy CFO Mike Lee dishes on growth expectations for fiscal 2020.

In a decade's time, the marijuana industry is going to be a veritable giant. Depending on your preferred source, Wall Street firms are projecting anywhere from $50 billion in annual worldwide sales to as much as $200 billion in cannabis and cannabinoid sales per year around the globe. These pie-in-the-sky sales figures have been a driving force behind pot stock valuations for years.

However, the near-term outlook for the industry isn't so "buzzy." A number of issues throughout North America have constrained sales and seriously hampered the operating results of some of the industry's biggest names. Perhaps none more so than the largest marijuana stock in the world by market cap, Canopy Growth ( CGC -3.57% ).

A jar packed with cannabis buds that's sitting on a fanned pile of twenty dollar bills.

Image source: Getty Images.

As expected, Canopy Growth won't be profitable in fiscal 2020

Last week, Wall Street investment firm Jefferies, which offers the tamest growth outlook for the global cannabis industry at $50 billion in sales by 2029, met with Canopy Growth's chief financial officer, Mike Lee, who was appointed to his post less than two months ago. Although a number of topics were covered, as noted by Jefferies' covering analyst Andrew Bennett, one important piece of information came to light that confirmed a suspicion I and most of Wall Street have had for quite some time: Canopy Growth won't be profitable in fiscal 2020 (Canopy's fiscal 2020 runs from April 1, 2019-March 31, 2020).

This should come as little surprise to investors, with Wall Street's consensus earnings per share in 2020 for Canopy having been decidedly in the negative since February, and the company reporting a monstrous net loss of 670 million Canadian dollars (about $513 million) in fiscal 2019.

But Lee revealed some additional details about Canopy that should rightly have Wall Street and investors tempering their expectations. Namely, Lee really pulled back from the idea that (now-previous) management had put out there that Canopy would hit CA$1 billion ($766 million) in sales in fiscal 2020. For the upcoming fiscal first quarter, through the end of June, Lee anticipates that sales and gross margin -- which was a meager 16% in the fourth quarter -- will be more or less comparable with the sequential fourth quarter. This certainly jibes with the slow uptick in sales at licensed cannabis stores in Canada, as well as Canopy's reliance on the recreational side of the market for revenue. 

A Canadian flag with a red cannabis leaf in place of the maple leaf, and the words Sold Out stamped across the flag.

Image source: Getty Images.

Three reasons Canopy Growth has no chance of a 2020 profit

If you're wondering why the largest marijuana stock in the world is forecast to be a laggard in the earnings department, it likely boils down to three factors.

First, point the finger of blame at Health Canada. At the end of last year, Health Canada had more than 800 licensing applications (cultivation, processing, and sales) on its desk to review. For context, Health Canada has approved fewer than 200 total licenses since 2013. Health Canada has recently implemented a fix for its seemingly insurmountable backlog of licensing applications, but it's still going to take many quarters to work through. That's left Canopy, a company with over 4.8 million square feet of already licensed grow space, unable to move much of its product or grow sales at a rapid pace.

Secondly, Canopy's growth strategy hinges on expansion into considerably larger markets than Canada. Though Bruce Linton is no longer the company's visionary and co-CEO, he orchestrated all of Canopy's major acquisitions and its push into new markets. He oversaw Canopy's win when it was awarded a hemp processing license in New York State, and played a key role in securing the contingent-rights deal to acquire U.S. multistate dispensary operator Acreage Holdings for $3.4 billion in a cash-and-stock deal, with the contingency being that the U.S. federal government has to legalize marijuana. Though Linton viewed this expansion as necessary for Canopy to reach its long-term goals and industry dominance, it's ravaged the company's bottom line.

A third and final reason Canopy Growth has virtually no chance of being profitable in fiscal 2020 is the company's share-based compensation. Linton angled to keep Canopy's ballooning workforce happy and loyal by setting them up with share-based compensation that vests over the long run. Despite looking out for his employees, former co-CEO Linton also ballooned share-based compensation expensing for Canopy in 2019. Investors can likely expect a repeat in 2020.

Scissors cutting a one hundred-dollar bill in half.

Image source: Getty Images.

Expect Canopy's new CEO to be cost-conscious above all else

When the company announced Linton's departure as co-CEO and board member on July 3, it also noted that the board was looking for a permanent CEO replacement. This means that while Mark Zekulin was "promoted" to CEO, he will also be stepping aside from his leadership role once that replacement is found (Zekulin was co-CEO with Linton).

As of now, no one is exactly sure who will head Canopy Growth into the next phase of its maturation process. However, one thing that's crystal clear is that whoever takes the reins is expected to keep a very tight leash on expensing. Though it could be difficult to deal with the share-based compensation set up while Linton was steering the company, Canopy's future CEO could certainly work to reduce operating expenses, future share-based awards, and the drag of acquisitions by simply being more selective about what companies Canopy buys.

But no matter who Canopy Growth's board chooses to be its new CEO, there doesn't appear to be a path toward profitability in 2020, and there's equally no guarantee that the big bucks will start flowing in during 2021, either.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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