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As Canopy Growth Loses $282.7 Million, Constellation Brand’s Headache Continues

By David Butler – Nov 15, 2019 at 7:03AM

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The Canadian marijuana producer reported another quarter of heavy losses, and markets were not forgiving.

Shares of Canopy Growth (CGC -7.00%) fell 14% Thursday after the Canadian marijuana company reported another quarter of big losses. The stock is a lesson in fundamentals. It was boosted by overspeculation by those trying to get in on the burgeoning marijuana industry. But the big losses associated with trying to build production of scale, along with developing sales in a new marketplace, are showing up in earnings. Shares have fallen roughly 65% over the past six months.

Obviously, speculation is part of the game when it comes to these companies, but getting too involved can really burn you. I credit much of the unrealistic rise in Canopy's stock to the billions invested by Constellation Brands (STZ 2.13%). When the alcohol conglomerate did that, it signaled to markets that Canopy was the real deal -- and it put a ton of cash into Canopy's pockets. This started a chain reaction in which the frenzy of legalization, the prospect of a large corporate partner, and the insane increases in revenue drove shares far higher than they should have been. Canopy's initial investments began in October of 2017. Constellation's second, and far more significant, investment of USD$4 billion came in August of 2018. Throughout all of this, the stock went on a run from around $10 a share to over $50. Obviously the stock has struggled to maintain that momentum over the course of the past year.

A tough fiscal Q2

When your stock is trading at levels that should be backed by earnings that don't yet exist, the downside potential is always there. Fiscal second-quarter losses of 374.6 million Canadian dollars ($282.7 million) were nowhere near as painful as the CA$1.2 billion loss reported in fiscal Q1, but that was still a 13% increase in losses year over year. The money bleed has done a whopper to the balance sheet. Total equity on the balance sheet has fallen by roughly 22.3% year over year to CA$5.62 billion.

Picture of marijuana leaf

Image source: Getty Images.

Canopy's cash on hand is down to a little over CA$1.1 billion compared with CA$2.48 billion a year ago. At the end of December 2018, it had CA$4.92 billion on hand. Since then, we've watched around 77% of its investment capital disappear.

There's a lot to complain about here. Share-based compensation expenses of CA$87.86 million in fiscal Q2 were higher than the CA$85.62 million in revenue created during the quarter. That's tough to justify when you're losing hundreds of millions of dollars.

Not all was bad. Net revenue increased 229% year over year to CA$76.6 million. Quarter to quarter, net revenue declined by 15%. Canopy still possesses a large cash position and marketable securities of $1.6 billion and has the opportunity and time to correct what's been going on.

Though it might sound obvious, the big fix here for Canopy would be using its cash more efficiently. It's very clear that markets are no longer interested in tolerating big losses from these marijuana names. Canopy needs to cut back on the spending and focus on turning a profit from the business it has built up to this point.

As I discussed earlier, Canopy Growth has one of the nicest balance sheets in the industry in terms of capital, but they've burned through much of it without producing comparable results. I get it. Expansion in a new industry is a bit tricky and expensive. Everyone wants to try to corner the market and be out ahead of everyone else, but the revenue that has been gained doesn't nearly equal the cash that has been lost. The recent note on overestimated CBD oil demand is a prime example that management isn't completely in touch with the market they're operating in.

After Co-CEO Bruce Linton stepped down, Mark Zekulin took on sole CEO duties. He's reportedly part of the team that is searching for a new chief executive to replace himself as well. I'd like to see someone that will focus on running Canopy like a matured business, rather than a growth engine.

The problems are a headache for Constellation Brands

Perhaps the biggest loser in this debacle is Constellation Brands. The unrealized gains and losses as Canopy Growth's stock edges up and down will continue to plague Constellation's quarterly results.

This is not to say that the investment is a total loss. Constellation still has a large stake in a company creating large revenue growth in a new industry. It's also still a good route for the cannabis-infused beverages we've been hearing about. No doubt there's a substantial consumer base for them. But it will be interesting to see if we get some more commentary and criticism from Constellation over the seemingly wasteful use of its investment.

As to whether Canopy's decline is finished, it's too early to tell. We still don't know who the permanent CEO will be once Mark Zekulin steps down, and issues during the quarter regarding losses on returned cannabis oil seem to imply that Canopy Growth doesn't completely understand the market yet. 

David Butler has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.

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