One of the big reasons Canopy Growth (CGC -3.52%) and other pot stocks have struggled so mightily over the past year is because of a lack of profitability in the sector. Losses, whether due to impairment or declining fair value, are the norm in the industry, which cannabis investors know is still growing and full of risk.
But for an industry leader like Canopy Growth, the clock is ticking to get to a more sustainable income statement. And now that it's got a new CEO, David Klein -- who's been brought over from the pot producer's key investor, beverage giant Constellation Brands (STZ 0.60%) -- there's even more pressure on the company to produce much better results in the near future. Let's take a look at the company's financials and assess whether profitability is likely in 2020.
How close is Canopy Growth to profitability today?
There was a lot of noise around Canopy Growth's fourth-quarter results, which the company released back on May 29. Canopy Growth incurred significant restructuring and impairment charges of 743 million Canadian dollars. The pot producer says that without such one-time charges, its adjusted gross margin would've come in at 42%, rather than the negative 85% that it reported in Q4.
But even if that were the case, the company's readjusted gross margin would total just CA$45.3 million.
That's nowhere enough to even cover the company's selling, general and administrative (SG&A) expenses of CA$197.6 million. Canopy Growth's operating expenses included significant impairment charges of CA$623.3 million. Those charges were a big part of the reason that Canopy Growth's net loss of CA$1.3 billion was so large, but even without them, the company's financials would still be in the red. When SG&A comes in higher than revenue, that's a big problem.
Assuming Canopy Growth's gross margin had come in at 42% in Q4, with no impairment charge, the Ontario-based company would still have recorded an operating loss of CA$230.6 million.
Rise in CEO pay may only make things harder
Another challenge for the company in its quest for breakeven: Its CEO is earning more than double what his predecessors were. Klein's base salary is $975k, or around CA$1.3 million annually. And that's before factoring in other incentives along the way. Both Mark Zekulin and Bruce Linton, the company's most recent CEOs, were making less than half of that.
Klein's cost-cutting measures, including laying off staff and cutting back global operations, may be needed just to make up the gap in executive pay. The increase in executive pay combined with the company's steep operating losses, which go beyond just one-time expenses, suggest that Klein will need to make even more drastic cuts needed to get Canopy Growth anywhere near profitability.
Will the company turn a profit?
Canopy Growth has a lot of work to do to become profitable. And the challenges that the COVID-19 pandemic presents will only make things more difficult this year, especially if the pandemic leads to a deep recession that weighs down sales. Without strong sales numbers, Canopy Growth could land deeper in the red, rather than closer to breakeven. In Q4, Canopy Growth's net revenue rose by 14.7%.
On its most recent earnings call, the company's CFO, Mike Lee, said that he doesn't expect gross margins to remain at 40% in upcoming quarters because of COVID-19, and that its Canadian operations feature "a real 28% to 30% gross margin." Although the longer-term target is for gross margin to come in well above 40%, it's clearly not something the company plans to accomplish this year or while COVID-19 is still weighing down the economy.
Klein also referred to the "medium term" as to when the company will expect to "deliver significant profit." However, it's not clear when that might be. At the very least, it likely won't happen this year.
Should you buy the stock?
If you're willing to hang on to shares of Canopy Growth for a year or longer, then it could be an attractive long-term buy. The company reported more than CA$1.3 billion in cash and cash equivalents on its books as of March 31. That should help get it through the pandemic, even though it did burn CA$772.6 million over the past 12 months. With a strong investor in Constellation Brands, which now owns 38.6% of the cannabis giant, Canopy Growth is one of the safer pot stocks investors can own today.
More losses this year could send the stock even lower, but over the long term, Canopy Growth's stock could produce some strong results for investors who buy today. There's still a lot of growth left in the industry, and Canopy Growth and the pot stocks that make it through the COVID-19 pandemic will be in great positions to benefit from it.
Although profits aren't on the horizon for Canopy Growth, the stock can still be a profitable long-term hold for investors. Year to date, shares of the pot stock are down by about 19%, which is in line with the 18% decline the Horizons Marijuana Life Sciences ETF (HMLSF 1.12%) has been on during that time.