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This Is the Biggest Problem in Canopy Growth's Q4 Earnings Report

By David Jagielski – Jun 5, 2020 at 10:45AM

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Another loss isn't what investors should be worried about.

Canopy Growth (CGC 0.84%) released its fourth-quarter results on May 29. The number that garnered attention was the company's mammoth loss, which totaled $1.3 billion Canadian dollars. It's another big loss from a company that's been no stranger to them in the past. And while that may be disappointing, there's a more troubling number that investors should be focused on -- revenue.

Sales were down 13% from the third quarter

In Q4, Canopy Growth reported net revenue of CA$107.9 million. That's up a modest 15% from the prior-year period where net sales were CA$94.1 million. That's in sharp contrast from the 76% sales growth that the pot producer generated during the full fiscal year.

What's perhaps even more concerning is that it was less than the CA$123.8 million that the Ontario-based cannabis company generated in its third-quarter. The Q3 revenue decline was caused by Canadian recreational revenue falling by 28%. Within this segment, business-to-business sales dropped by 31%, while consumer revenue was down by 14%.

Cannabis greenhouse.

Image source: Getty Images.

The company says that business sales were down because there was less demand for flower and pre-rolled joints. On the consumer side, it blamed the results on "expected off peak seasonal demand decline," as well as store closures amid the COVID-19 pandemic.

Why investors expected stronger sales

The results are surprising given that in March, consumers were stockpiling cannabis. At the Ontario Cannabis Store, sales were up 100% from the previous week at one point. But it's important to note that the online store also slashed many prices to offer more competitive products, which may have contributed to the surge while potentially diverting sales away from Canopy Growth.

The cannabis company announced it would begin shutting down its stores on March 17 after many retailers were already seeing spikes in sales. Blaming COVID-19 for the drop in sales is a convenient excuse but shouldn't distract investors from the big question surrounding the company's ability to generate sales growth. The rate of sales growth been slowing down, even as cannabis 2.0 products are rolling out.

In Q4, the company grouped cannabis 2.0 sales with oils and softgels. Revenue from that segment was CA$6.3 million, a 34% improvement from Q3. With demand up during the month of March and cannabis 2.0 sales also on the rise, this quarter should've been much stronger for Canopy Growth, at least on its top line.

Why things may not get better anytime soon

Since coming over from Constellation Brands (STZ -0.05%), which now owns 38.6% of Canopy Growth, new CEO David Klein has shifted the pot producer's focus from growth to profitability. To do that, the company needs to get leaner and bring down its costs. In addition to layoffs, the company exited South Africa and Lesotho and scaled back operations in other parts of the world.

In its Q4 release, Canopy Growth referred to fiscal 2021 as a "transition year" as it "resets its strategic focus." Those aren't words that are going to excite growth investors. Not only will COVID-19 create some new challenges this year, especially if a decline in the economy leads to fewer sales, but a significant change in strategy for Canopy Growth could make it even more difficult to generate the kind of sales growth the company's seen in the past.

And if Canopy Growth isn't seeing its sales numbers rise in the new fiscal year, there may be even less hope of the company finishing in the black anytime soon.

Should investors steer clear of Canopy Growth?

There's reason to be optimistic about what the company's new CEO is doing. While there will be short-term pain as a result of a refocused strategy, over the long term, it's likely to make the company a much better investment overall.

But the stock's still an expensive buy with shares trading at 19 times the company's sales. That's a pretty steep multiple, given that rival Aurora Cannabis trades at just six times revenue.

Canopy Growth's high price-to-sales multiple combined with the likelihood that its sales could continue to take a hit this year means it's not a terribly appealing time to buy Canopy Growth stock right now. Investors looking to buy shares of the pot stock may want to hold off, as these latest quarterly results raise some concerns about just how strong the company's market share is. For an industry where revenue growth is key, there may not be much bullishness surrounding the stock this year.

Thus far in 2020, shares of Canopy Growth are down more than 20%, which is worse than the performance of the Horizons Marijuana Life Sciences ETF, which is down 16%. The problem is that Canopy Growth shares could be headed even lower this year if its sales numbers continue to struggle.

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

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Stocks Mentioned

Canopy Growth Stock Quote
Canopy Growth
CGC
$2.76 (0.84%) $0.02
Constellation Brands, Inc. Stock Quote
Constellation Brands, Inc.
STZ
$232.55 (-0.05%) $0.11
Aurora Cannabis Stock Quote
Aurora Cannabis
ACB
$1.18 (1.78%) $0.02
Horizons Marijuana Life Sciences Index ETF Stock Quote
Horizons Marijuana Life Sciences Index ETF
HMLSF
$4.00 (-11.90%) $0.54

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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