Canopy Growth (CGC -3.01%) may not be the most popular pot stock in the world, but it's undoubtedly an industry trendsetter as the largest marijuana stock by market cap. That's what made its fiscal third-quarter earnings release on Friday, Feb. 14, a must-see for Wall Street and cannabis stock investors.
Just a week prior to releasing its Q3 report, Wall Street was looking for 104.2 million Canadian dollars in revenue ($78.7 million U.S.) and a loss of CA$0.38 per share. But despite pessimism persisting in the cannabis space, Canopy Growth blew past these projections. Net sales, after accounting for excise taxes, surged to CA$123.8 million from an adjustment-laden CA$76.6 million in the sequential second quarter. Meanwhile, Canopy's per-share loss of CA$0.35 was a bit narrower than expected.
In some ways, the fiscal third quarter delivered exactly what Wall Street and investors needed to see. But in other respects, it was more of the same from money-losing Canopy. Let's take a closer look at three things you should absolutely love and hate about the recently ended quarter.
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Three things to love about Canopy Growth's third quarter
Putting the headline numbers aside for a moment, I believe the most impressive aspect of Canopy's third quarter was the progress management made on reducing costs. In particular, share-based compensation, which has unquestionably been this company's Achilles' heel in recent quarters, declined by more than CA$31 million from the sequential quarter. Canopy's general and administrative expenses also fell by about CA$20 million, helping to push total operating expenses down by 14% from Q2 2020. It's important and noteworthy that these cuts were undertaken before new CEO David Klein took the helm in January. Klein is widely expected to continue Canopy Growth's belt-tightening.
Secondly, it's very encouraging to see that Canopy Growth didn't have to take any price or inventory-based adjustments during the fiscal third quarter. As I'd alluded to earlier, Canopy's "adjustment-laden" fiscal second quarter wound up reducing net revenue by CA$32.7 million. This $32.7 million was tied to pricing adjustments and inventory writedowns tied primarily to its softgel product line. Early-stage supply issues in Canada have been problematic and led to a number of bottlenecks in certain provinces (ahem, Ontario). Though Canopy's net sales suffered in Q1 2020 and Q2 2020 as a result of adjustments, it looks to have put these inventory and pricing issues firmly in the rearview mirror.
Lastly, a lot of credit goes to Canopy for its ancillary revenue sources. During the third quarter, "other" revenue (i.e., anything that doesn't involve growing and selling cannabis) grew by 42% from the sequential second quarter to CA$33.4 million, and more than quadrupled from the prior-year period. A surprising driver here was Storz & Bickel, which Canopy acquired last year. The maker of vaporizers bucked the weakness caused by health concerns surrounding e-cigarettes and vaping and delivered 46% sales growth from the sequential second quarter.
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Three things to hate about Canopy's recently ended quarter
Of course, there's another side to this story.
Perhaps the most disappointing aspect of Canopy Growth's third-quarter operating results is that its international sales went virtually nowhere. Despite having access to 16 markets outside of Canada, international medical cannabis sales totaled only CA$18.7 million, which is a less than 3% increase from the sequential second quarter. If there is a mild plus here, higher-margin oils and softgels did see a 6% uptick in terms of overseas sales. Nevertheless, considering that medical pot patients often generate much juicier margins than recreational users, it's disappointing to see such sluggish growth in international markets.
Secondly, there has to be some concern that the combination of ongoing operating losses, projects, and merger and acquisition activity is depleting the company's cash position. Inclusive of cash, cash equivalents, and marketable securities, Canopy ended calendar 2019 with CA$2.27 billion. That's still more than any other cannabis stock, but it's down close to CA$470 million from the end of September, and is well off the nearly CA$5 billion it ended with in calendar 2018. There's real urgency here that cost-cutting needs to happen.
Third and finally, Canopy Growth's goodwill has again ticked higher. When the quarter came to a close, Canopy had CA$2.07 billion classified as goodwill, with another CA$567.2 million recognized as intangible assets. All the while, ongoing losses and the noted reduction in cash has pushed its total assets down to CA$8.05 billion. This means goodwill, which accounted for 23% of total assets in Q2 2020, now accounts for 26% of total assets. When goodwill is combined with intangible assets, a third (33%) of Canopy's total assets are based on hope and promise. This is suggestive that a writedown may be in order for the company.
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Canopy takes a step forward, but is still worth avoiding like the plague
While there's no doubt that Canopy Growth's operating results wowed Wall Street last week, and the company's early cost-cutting efforts should be commended, there's still not a compelling reason to put your hard-earned money to work in this stock.
On a broader basis, we're still liable to see supply issues persist in Ontario, the country's most populous province, throughout the remainder of 2020. Thankfully, Ontario has abandoned its lottery system in favor of a more traditional licensing system where applicants are vetted by regulators. This should allow the number of dispensaries open to surge from 24 on Oct. 17, 2019, to perhaps 250 by Dec. 31, 2020. Nevertheless, the increase in open locations will be gradual, and illicit growers are liable to maintain the lion's share of pot sales in the province.
Canopy Growth's ticket to high-margins sales has also been pushed further down the road. In January, the company announced that it was delaying the launch of cannabis-infused beverages because it hadn't completed the buildout of its production line. And, as noted above, international sales have been relatively unimpressive with a number of overseas countries still working out the regulations concerning their medical marijuana laws.
There's also the very real possibility of a writedown in the foreseeable future. Canopy Growth is unlikely to recoup anywhere close to $2.07 billion in premium paid for the businesses it's acquired, which is now being classified as goodwill.
These are all great reasons to monitor Canopy Growth from the safety of the sidelines.
