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5 Things to Know About Canopy Growth's Q3 Report

By Sean Williams - Feb 6, 2020 at 6:51AM

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Here's what you need to know ahead of Canopy's earnings release next week.

It's nearly time for the biggest cannabis stock on the planet by market cap, Canopy Growth (CGC -6.16%), to deliver its fiscal third-quarter operating results. According to the company's upcoming investor events, its Q3 results, which encompass its operating activity through the end of December, are due to be released on Valentine's Day, Feb. 14.

Wall Street will be looking for Canopy Growth to report $104.2 million Canadian in sales ($78.4 million U.S.), representing 25% year-on-year growth, with a net loss of CA$0.48 per share, which would be modestly wider than the CA$0.38 per share loss recorded in Q3 2019.

But the fact is that there's much more pot stock investors need to be aware of than just Canopy Growth's headlines figures. Here are five things you'll want to know and/or should expect as the largest weed stock in the world gets ready to report.

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

Image source: Getty Images.

1. Derivatives won't play a big role in its quarterly earnings

To begin with, it's important to realize that derivative pot products, such as edibles, infused beverages, and vapes, were only launched in mid-December after Health Canada pushed back their launch date by about two months. This means derivatives aren't going to play much of a role at all in the company's operating results, which are through Dec. 31.

This is notable because derivatives are expected to be a considerably higher margin product than traditional dried cannabis flower. Investors are counting on pot stocks to get more bang for their revenue buck with derivatives, but their impact continues to be pushed further down the road.

It's also worth pointing out that Canopy Growth announced its launch of cannabis-infused beverages would be delayed. Though the company believes it's made progress on ramping up operations for its beverage line, it didn't feel that, seven weeks after receiving its license from Health Canada in November, it was ready for commercial production and launch. All of these factors mean that Canopy will continue to be reliant on generally lower-margin cannabis products in the very near term.

Scissors cutting a one hundred dollar bill in half.

Image source: Getty Images.

2. Cost-cutting isn't going to show up until the following quarter

As some of you may recall, now-former co-CEO and visionary Bruce Linton was fired in early July, with his co-CEO (and subsequent CEO) Mark Zekulin stepping down in December. Replacing Linton and Zekulin at the helm is David Klein, Constellation Brands' (STZ 0.29%) former chief financial officer. Constellation Brands is Canopy's major equity investor.

Klein is heralded by Canopy's remade board and its equity partner as having plenty of consumer-packaged goods experience, and takes over the reins with the expectation that he'll do some serious belt-tightening. After all, Canopy Growth has lost a staggering CA$388.9 million on an operating basis through just the first six months of fiscal 2020, with CA$180 million in operating expenses alone being some form of share-based compensation.

But what investors should realize is that, while Klein intends to reduce spending, none of these cost-cutting actions are likely to have taken shape in any meaningful way during the fiscal third quarter. Klein didn't even take over as CEO until Jan. 2020, meaning expenditures for Q3 2020 are still likely to be very high.

A handful of dried cannabis buds lying atop a messy pile of cash.

Image source: Getty Images.

3. Sequential quarterly revenue should be up significantly

On the bright side, there's a very good possibility that we'll see Canopy Growth report net sales that are up significantly from the sequential second quarter. That's because Canopy has, in two consecutive quarters, taken some notable inventory and price adjustments. In the fiscal second quarter, these adjustments wound up costing the company CA$32.7 million in lost revenue.

However, with Canopy making the tough decision to correct its inventory (mostly oils and softgels) in the fiscal first and second quarters, it paves the way for either a much smaller inventory writedown or adjustment in Q3 2020, or perhaps none at all.

It's important to note that even if Canopy Growth generates CA$104.2 million in revenue as expected, this only represents very modest growth over the full year. In short, keep things in perspective when looking at the headline sales figure.

A person holding cannabis leaves in front of a globe of the Earth.

Image source: Getty Images.

4. International revenue might be the real star

Another area of intrigue for Canopy Growth is international sales.

For most marijuana companies, international sales have been a source of frustration. It's been difficult for growers to get the licensing to export product overseas, and quite a few overseas markets where medical marijuana is legal have been slow to implement regulations regarding consumption, use, and imports.

Interestingly, though, Canopy Growth, which has the second-largest overseas presence (16 countries outside Canada), managed CA$18.1 million in overseas medical pot sales in the fiscal second quarter. This accounted for 19% of the company's cannabis gross revenue in Q2 2020, before adjustments. There's no doubt that international markets should be a larger long-term revenue driver for the company than Canada, so this 72% sequential quarterly growth in overseas sales was an eye-opener.

For the fiscal third quarter, it's possible overseas sales again become the real star of the report. With higher-margin extract sales finally picking up in some international markets, Canopy's modest sales growth could be saved by a sizable uptick in overseas cannabis revenue.

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

Image source: Getty Images.

5. Expect Canopy's balance sheet to have further deteriorated

Last, but not least, investors should expect ongoing deterioration (albeit not severe) in Canopy's balance sheet.

To be clear, Canopy Growth remains the most cash-rich cannabis stock on the planet, thanks to a $4 billion equity investment (that's in U.S. dollars) from Constellation Brands in November 2018. Then again, having reported close to CA$5 billion on its balance sheet as recently as Dec. 31, 2018, Canopy's cash, cash equivalents, and short-term investments were down to CA$2.74 billion as of Sept. 30, 2019. With the company generating large operating losses and getting aggressive with its domestic and international expansion, this cash hoard is quickly being whittled away.

At the same time, Canopy's aggressive expansion included a number of acquisitions, many of which now look to have been grossly overpriced. Having ended the previous quarter with CA$1.91 billion in goodwill (that's the second-highest in the cannabis industry), a decline in the company's cash will probably lead to goodwill accounting for an even higher percentage of total assets. With each passing quarter, Canopy looks like an even greater candidate for a sizable writedown. 

With all of this knowledge in mind, now we simply watch and wait for Canopy Growth to deliver the goods.

Sean Williams 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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