Is Canopy Growth at Risk of Going Bankrupt?

Cannabis companies have been reporting significant losses thanks in large part to widespread COVID-19 lockdowns. Canopy Growth (CGC 15.03%), one of the largest pot producers, startled investors last week when it reported a CA$1.3 billion net loss for its fiscal fourth quarter.

Although Canopy is known for being one of the best-funded pot stocks, its enviable cash position has been rapidly declining over the past year or so. Following this significant quarterly loss, should investors be worried about a Canopy Growth bankruptcy in 2020?

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Why are losses so high?

Taking a look at the financial results, net revenue came in at 107.9 million Canadian dollars, which is a 13% decrease from the previous quarter. More specifically, just under half of all revenue came from recreational sales in Canada (around CA$49.8 million), a figure that has fallen by 28% since fiscal Q3 2020.

A slowdown in sales was to be expected due to lockdowns, especially since dispensaries are deemed nonessential businesses in some provinces (most notably Ontario) and are required to stay closed until lockdowns are lifted. However, net losses are substantially worse than what's normal for the company. Canopy saw net losses jump to a staggering CA$1.3 billion, much lower than the CA$124.2 million net loss reported back in the previous quarter.

While this might seem alarming at first, just over half of this net loss, CA$743 million, is due to asset impairment and restructuring expenses. However, that still leaves around CA$557 million in losses for the quarter, which is pretty high even for Canopy.

Regular operating expenses have increased by 17% since the previous quarter. Even looking at a longer period, certain expenses, such as cost of goods sold, have more than doubled between Q4 2019 and Q4 2020. In comparison, quarterly revenues have hardly increased over this past year, growing from CA$94.1 million to just CA$107.9 million.

Could things get worse?

This isn't the first time that Canopy Growth has reported a billion-dollar-plus loss. In August 2019, Canopy reported another CA$1.3 billion loss during its fiscal first quarter. While those losses weren't due to restructuring costs (rather to adjustments for warrants regarding a planned U.S. acquisition), it does go to show that Canopy has a history of reporting major quarterly losses.

Of course, Canopy is one of the best-financed pot stocks on the market. Its current cash and position of around CA$1.3 billion beats the vast majority of cannabis companies. However, this has dwindled significantly from last year's CA$2.5 billion in cash. Short-term investments, which can be sold quickly for cash, have also declined substantially from last year, down from CA$2.0 billion to just CA$673.3 million as of Q4 2020.

Investors can't deny that Canopy Growth is running out of cash fast. Even if you factor out these restructuring costs, that will put Canopy's quarterly losses at around CA$557 million. Combining the company's cash and short-term investments, that would give Canopy less than one full year of financial breathing room if the company manages to keep its expenses around this level. Over a billion in cash might look like plenty on paper, but it will quickly be spent if things don't change.

Here's where Canopy's finances stand now:

Data source: Canopy Growth. All figures in Canadian dollars.

Investors also need to consider that Canopy still has CA$2.4 billion in goodwill and intangible assets just sitting on its balance sheet. Goodwill represents a premium that most companies offer when making an acquisition to sweeten the deal for the acquiree. Thanks to all the acquisitions Canopy has made over the years, this goodwill figure has ballooned to a substantial size. With more uncertainty now than ever surrounding the cannabis market, it's becoming harder for companies to justify why these assets shouldn't be written down to a lower, more sensible price point.

That's precisely what happened earlier this year with Aurora Cannabis, whose shares tanked after announcing a surprise CA$1 billion goodwill adjustment. Considering how much goodwill Canopy still has on its balance sheet, it wouldn't be surprising if further adjustments are needed to be made in the future. These losses would only further eat away at its already diminishing cash position.

Should investors be worried?

Canopy's management called 2020 a strategic "reset" as the company tries to figure out a path to profitability. This is in addition to previous measures, such as shutting down a number of cultivation and processing facilities around the world as well as significant layoffs.

However, there could be some good news on the horizon. With COVID-19 lockdowns easing up in Canada, people are returning to shopping malls and retail outlets across the country. In turn, cannabis sales could see a major upturn as consumers across the country start visiting dispensaries once again. However, I don't think this uptick in revenue would be enough to completely mitigate the company's already significant operating expenses, let alone future potential goodwill adjustments or restructuring costs.

With other Canadian cannabis companies like Aurora already teetering on the brink of financial oblivion, Canopy could end up in a similarly dire position if things don't change soon. Of course, Canopy's management team knows this and the company's already financially stringent new CEO, David Klein, won't let that happen.

Unlike his predecessor Bruce Linton, who was well known for offering stock incentives to employees, Klein has opted for a cost-cutting philosophy following Canopy's alarmingly high losses. This makes sense considering Klein's previous background as the CFO for Constellation Brands, one of Canopy's largest investors.  (STZ 0.74%)

It's worth mentioning that Canopy could always turn to Constellation Brands for more financing. In 2018, Constellation invested over CA$5 billion into Canopy, and then in early May, Constellation upped its stake in Canopy to 38.6%, netting Canopy about CA$245 million. The alcohol-giant has a vested interest in seeing Canopy succeed. However, both parties would likely only pursue further investment if absolutely needed, especially since Constellation has technically lost money on its original investment due to how far Canopy's stock has fallen.

In the end, Canopy stands a decent chance of making it through this year and beyond if its management team reins in the spending. However, it will take only one or two more bad quarters like this one before it will need to look for further financing somewhere, whether that be from Constellation Brands or otherwise. If you're thinking about investing in this stock right now, it might be prudent to wait a few more quarters to see if new management can shrink Canopy's net losses.