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Surprise! Canopy Growth Strikes Out Again

By Sean Williams - Jan 23, 2020 at 6:06AM

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Will anything ever go as planned for the largest pot stock in the world?

The past nine-plus months have not been pretty for cannabis stock investors. Last year began swimmingly, with over a dozen pot stocks galloping higher by more than 70% during the first quarter. However, since the end of March, supply issues in Canada, high tax rates in select U.S. states, and a resilient black market throughout North America have combined to clobber marijuana stocks.

Perhaps none of these has been more visibly pummeled than Canopy Growth (CGC -1.40%), the largest pot stock in the world by market cap. At one point, Canopy's market cap declined by more than $10 billion from peak to trough in 2019, with a number of miscues weighing on the company.

Unfortunately, 2020 hasn't begun any better for Canopy, with the company once again striking out with investors after providing an update on its line of Cannabis 2.0 products.

A cannabis leaf lying atop the carbonation in a glass, with other cannabis leaves to the right of the glass.

Image source: Getty Images.

Canopy Growth won't be launching infused beverages on time

On Jan. 17, Canopy Growth announced that its nonalcoholic cannabis-infused beverages would not hit dispensary shelves as soon as initially planned. The press release notes that Canopy has made significant progress in scaling its infused-beverage production since receiving its license from Health Canada in November, but that the scaling process isn't complete. Rather than rush product to market, Canopy plans to take its time to maximize the efficiency of its beverage production line. 

According to the release, this delay isn't expected to have a material effect on Canopy's full-year sales, but the company is expected to provide more color on the delay and how it'll affect its top line with the release of its fiscal third-quarter operating results in mid-February.

What's particularly worrisome about this update is that Canopy doesn't expect a material impact from the late launch of infused beverages. They are expected to be a core revenue-driving derivative for cannabis stocks, which makes it odd that this delay isn't going to harm Canopy's top line. This might suggest that infused beverages are expected to be a slow starter in the sales department, or that competition in this market will be fiercer than expected.

It's also a bit unnerving that Canopy Growth is unable to launch its infused beverages on time while working with Constellation Brands (STZ 1.02%) as its equity investment partner. Developing, launching, and marketing beverages is Constellation's entire business model as a spirits company, and Constellation holds a more than 35% stake in Canopy Growth. The fact that Canopy has thus far been unable to deliver on this high-margin product is a bit of a head-scratcher.

A person holding a magnifying glass above a company's balance sheet.

Image source: Getty Images.

Canopy Growth continually disappoints investors

This isn't the first time that a Canopy Growth initiative failed to materialize as planned.

For example, now-former CEO Bruce Linton believed that rewarding Canopy's rapidly growing employee base with long-term-vesting stock would be a smart way to encourage loyalty and align employees with the company's long-term goals. But handing out long-term-vesting stock like Monopoly money has meant recognizing these shares as an expense on the company's income statements. In the fiscal second quarter, share-based compensation outpaced the company's net sales, demonstrating what little chance it has of generating an operating profit anytime soon.

Canopy Growth's foreign-market push has also proved to be a disappointment in the early going. On paper, it seemed wise to establish a production, export, research, or partnership presence in more than a dozen countries outside of Canada. Being able to export weed to foreign markets, if and when dried flower becomes oversupplied and commoditized, seems like a smart plan. But these overseas markets are more of a moot point since Canadian demand is nowhere near being met, and foreign countries are still establishing medical cannabis legislation of their own. For now, these hefty investments are yielding virtually no return.

We've also witnessed Canopy Growth's aggressive acquisition strategy backfire. In recent years, it's made numerous acquisitions designed to do everything from bolster its production and portfolio to helping with back-end sales. But Canopy's goodwill has ballooned to 1.91 billion Canadian dollars ($1.46 billion) as of the fiscal second quarter, suggesting that the company grossly overpaid for its purchases. This represents 23% of the company's total assets, and it'll likely continue growing as a percentage of total assets given Canopy's huge operating losses and shrinking cash pile. In short, the company's aggressive acquisition plan may result in hefty future writedowns.

Scissors cutting a one hundred dollar bill in half.

Image source: Getty Images.

Good luck, Mr. Klein

Perhaps the icing on the cake is that Canopy Growth now has a new CEO: David Klein, the former CFO of Constellation Brands. As CEO, Klein will have to find a way to seriously tighten the belt at Canopy, while also guiding this brand-name pot stock to significant growth. It'll be no easy task, and it certainly hasn't started off on the right foot given the delay in the infused beverage launch.

As an individual with knowledge of the consumer packaged goods (CPG) industry, Klein should have little trouble cutting costs at Canopy. Simply ending the company's acquisition spree, as well as halting the handout of long-term-vesting stock to employees, should give the company a realistic shot at reducing expenses and becoming profitable on a recurring basis by as soon as fiscal 2022.

Then again, having knowledge of the CPG industry is not the same as understanding how the cannabis industry works. With less in the way of capital expenditures to deploy, Klein is going to have to figure out how to effectively gobble up market share.

All I can say is, good luck, Mr. Klein.

As for investors, keep your distance.

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