Canopy Growth (CGC -0.66%), Canada's second-largest licensed marijuana cultivator, delivered its fiscal second-quarter earnings before the opening bell Thursday morning. In response to that report, its shares sank by around 11% in pre-market trading.
If that initial market reaction holds up through the day, shares of the pot titan will end the first four days of trading this week down about 23%. That's a worrying sign: Canopy's half-a-year-long slide lower might be starting to accelerate as 2019 winds down.
Image Source: Getty Images.
Should shareholders add to their holdings of Canopy Growth in the wake of this latest decline, or is it time to abandon ship? Let's break down the company's quarterly numbers to find out.
The good, the bad, the ugly
Canopy's fiscal Q2 report revealed two positive developments. First, the company's gross cannabis revenues rose by a modest 2% to 94.7 million Canadian dollars compared to the first quarter, when excluding the portfolio restructuring costs. Second, it exited the period with a healthy CA$2.7 billion in cash, cash equivalents, and marketable securities. Unfortunately, that's where the good news ends.
The bad news is that Canada's legal marijuana market continues to exhibit serious structural problems that are handicapping all of the country's licensed cultivators. As Canopy CEO Mark Zekulin commented:
The last two quarters have been challenging for the Canadian cannabis sector as provinces have reduced purchases to lower inventory levels, retail store openings have fallen short of expectations, and Cannabis 2.0 products are yet to come to market
As for the ugly, Canopy took a whopping CA$32 million restructuring charge related to the returns, return provisions, and pricing allowances for its softgel and oil portfolio. Pouring salt into the wound, the company also recorded an inventory charge of CA$15.9 million for the quarter. As a direct result, its Q2 net revenue of CA$76.6 million missed Wall Street's consensus estimate by an eye-catching 27.5%. That's seriously bad any way you slice it.
Buy or sell this news?
The cold, hard truth is that Canopy's shares will probably continue to fall for a long time, for a few reasons. Firstly, the company's valuation remains detached from the underlying realities of the legal marijuana industry. Canopy's shares, for instance, are still trading at more than 8 times next year's projected sales -- even though there's a strong chance that the company will end up falling well short of those rather optimistic revenue projections. The numerous problems plaguing the Canadian cannabis market could take years to remedy.
Investors seemingly bid up all of these marijuana stocks over the past two years in the hope that the U.S. would quickly legalize the drug at the federal level -- which would open up what is estimated to be a $100 billion a year marketplace. While Congress has taken some small steps toward that in 2019, there's no clear line of sight toward the end of the federal prohibition on cannabis in the United States. Frankly, this issue has barely been touched on by any of the contenders in the 2020 presidential campaign.
Bottom line: Between the structural problems within Canada's legal marijuana market and the lack of progress toward countrywide legalization in the much larger American market, Canopy's shares are highly unlikely to rebound anytime soon.
