As the broader stock market continues to recover from its March lows, the cannabis industry has also been performing better. But given that this sector remains significantly down from the levels reached two years ago, the road to full recovery for cannabis stocks is still long.
Canopy Growth (CGC 20.65%), one of the world's largest pot growers by market cap, is down by 16.6%, after plunging by more than 50% during the first few months of the year. Canopy's performance trails that of the Horizons Marijuana Life Sciences ETF (HMLSF 0.62%) -- an industry benchmark -- which is down by 15.4% since the year started. Could this be an excellent opportunity for investors to buy shares of Canopy while they're cheap?
Canopy's fourth-quarter results did the company no favors
Canopy recently released its earnings report for the fourth quarter of its fiscal year 2020. The company's financial results were underwhelming, to say the least.
During this quarter, Canopy reported net revenue of 107.9 million Canadian dollars, a 13% sequential decrease. The company's top-line decrease was primarily due to lower sales volume in the recreational cannabis market in Canada. During Canopy's fourth-quarter earnings conference call, the company's CEO, David Klein, said that Canopy lost market share in the Canadian recreational market.
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Canopy also reported an operating loss of CA$991 million, and the company's net loss was about CA$1.3 billion. It is worth noting that Canopy's total operating expenses of CA$899.2 million increased by 288% sequentially. Significantly higher operating costs and lower sales are a terrible combination -- for any company. Is there anything to look forward to for Canopy?
Reasons to be optimistic
During the fourth quarter, revenue from cannabis derivative products accounted for less than 2% of Canopy's sales. But it has been less than a year since the cannabis derivative market, known as "Cannabis 2.0" officially opened in Canada, and this market could present a significant tailwind for Canopy. For its ongoing quarter, Q1 2021, cannabis derivative products already account for more than 9% of the company's sales, according to Klein.
The demand for cannabis products in Canada also surged in mid-March as social distancing measures started being implemented. Similar trends have been observed in several U.S. states, and with recent reports suggesting that cannabis could be effective in treating COVID-19, I expect the demand for cannabis products to remain relatively high, or at least it is unlikely to decrease significantly. Canopy should be able to profit from these trends in its domestic market, and the company's sales should rebound in the coming quarters.
Furthermore, Canopy is currently on a mission to reduce cash burn. Klein said:
We've made substantive reductions to head count, divested redundant production assets, and exited some markets in order to reduce our cash burn and increase our focus. This is not a quick transition, but the beginning of a journey that will put us firmly in the ranks with the top consumer products companies in the world.
It helps that Canopy is one of the most cash-rich cannabis companies in Canada: As of March 31, the company's gross cash balance was CA$2 billion. One of the reasons behind Canopy's big pile of cash is its partnership with Constellation Brands (STZ 0.53%). In 2017, the beverage maker invested CA$245 million and acquired a 9.9% stake in Canopy, as well as warrants that gave Constellation Brands the option to up its stake in Canopy at a later date.
Then in 2018, Constellation Brands invested an additional CA$5 billion in the pot grower, bringing its stake in Canopy up to 37%. Further, in early May, Constellation Brands exercised the warrants acquired in the first deal between the two entities and increased its stake in Canopy to approximately 38.6%.
Klein, Canopy's current CEO who was appointed in December, is the former CFO of Constellation Brands (STZ 0.53%). With the two companies being practically tied at the hip -- and with Constellation Brands holding a significant percentage of the outstanding shares of Canopy -- investors can be confident that the beverage maker will devote the resources necessary to ensure that Canopy succeeds in the long run. This means that Constellation Brands will make use of its capital and expertise to open doors that would have otherwise remained closed for Canopy.
Thanks to these factors, Canopy should be able to navigate the current crisis and eventually turn things around.
Image Source: YCharts
Is it a buy?
In my view, Canopy remains one of the best cannabis stocks to buy, particularly compared to most of its peers in the Canadian market. But I think the sector will remain volatile for the foreseeable future, and while Canopy may be one of the winners in the long run, in my opinion, there are much better investment options out there. Still, for those comfortable with a relatively high level of volatility -- and who are willing to hold onto the company's shares for a while -- it might be worth considering buying Canopy's stock.
