For years, there wasn't a hotter industry to invest in than marijuana. Practically every pot stock rocketed higher on promises of capacity expansion, acquisitions, international exports, or partnerships.
But as is common with every fast-growing trend, the growing pains have arrived. For the past 16 months, investing in cannabis stocks has been painful, with many losing at least half of their value, if not more. One name, in particular, that's really taken it on the chin is the largest marijuana stock in the world by market cap, Canopy Growth (NYSE:CGC).
Canopy's first-quarter results created a buzz on Wall Street
Canopy is an interesting case, as it's the most cash-rich of all marijuana stocks. On four separate occasions since October 2017, it's received a direct or indirect investment from spirits giant Constellation Brands (NYSE:STZ). With abundant funding, a penchant for acquisitions and international expansion over the past couple of years, and now a CEO (David Klein) with an eye for cost management, investors have simply been waiting for Canopy Growth to put the puzzle pieces together.
Earlier this week, Canopy reported its fiscal first-quarter operating results (ended June 30, 2020), and its stock received quite the reception from Wall Street. Shares were, at one point, higher by a double-digit percentage after the company recorded 22% net revenue growth from the prior-year period.
There's no doubt that there were some highlights worthy of praise. For instance, Canopy Growth appears to be lone weed stock that's generating significant revenue outside of its home market. Global medical pot revenue soared 54% to $34.1 million Canadian dollars.
Additionally, the company reported that its recreational derivative products (non-dried-flower consumables) accounted for 13% of Canada's business-to-business sales during the quarter. These higher-margin products are going to be critical from a long-term profit perspective.
Canopy Growth's Q1 wasn't as good as you think
But upon closer inspection of Canopy's Q1 results, I'm just not that impressed. This looks like another dud of a quarter -- and here are five reasons why.
1. Canadian sales fell flat
First off, Canopy Growth's sales growth doesn't pass the sniff test upon deeper analysis. As the company notes, acquisitions played a notable role in the reported 22% sales growth. Excluding acquisitions, net sales only improved by 9% from the prior-year period.
However, what's really disappointing is how poorly Canopy performed in its home market. Citing an increase in dried flower competition and a "restricted retail operating environment in response to the COVID-19 pandemic," Canopy delivered CA$44.2 million in Canadian recreational revenue, down 11% from the prior-year period. Even with CA$7 million in recreational derivatives being sold and Canopy rightly taking a good percentage of infused beverage market share, Canadian adult-use sales fell by double digits as dry bud revenue dropped 34% from the prior-year quarter.
And, mind you, this weakness come as cannabis store revenue in Canada hit an all-time record high of CA$185.9 million in May, up more than 20% from the CA$154.1 million consumers bought in January 2020. Canopy really has no excuse for how poorly it's performing in Canada.
2. There's not nearly enough cost-cutting
Secondly, I really expected more from David Klein on the cost-cutting front.
In early March, the company announced that it would be permanently closing two its indoor greenhouses in British Columbia that housed 3 million square feet of licensed cultivation, and would also not open up the Niagara-on-the-Lake greenhouse. All told, this was over 3.3 million square feet of indoor grow space that was scrapped. When combined with reduced share-based compensation, job cuts, and Klein's acumen as former CFO of Constellation Brands, I expected some serious progress. What investors got, instead, was very modest cost reductions.
Though I will commend Klein for reducing year-over-year share-based compensation by 65%, CA$30.7 million for quarterly share-based payouts is still ridiculously high for a company that's been losing money hand over fist.
What's more worrisome is that selling, general and administrative (SG&A) expenses only fell CA$10.3 million to CA$135.4 million from the prior-year period. Even with all of Canopy's job cuts and greenhouse closures, Klein is struggling to keep SG&A costs down.
3. Adjusted EBITDA showed virtually no year-over-year improvement
Another cause for concern can be found in the company's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).
More specifically, Canopy's adjusted EBITDA of minus CA$92.2 million shrunk by only CA$1.2 million from the prior-year period. Though adjusted EBITDA isn't without its flaws as a financial metric, the key point here is that Canopy's push toward becoming profitable and an overall healthier company, financially speaking, is going to take much longer than Wall Street and investors anticipate.
Let's not overlook at that the company's gross margin was a meager CA$6.5 million on CA$110.4 million in sales, with operating expenses of CA$178.9 million. Without including a number of one-time benefits and costs, Canopy Growth's operating loss was over CA$172 million.
4. Its cash position was only buoyed by a direct equity investment
Canopy Growth was probably thrilled to point out to investors that its cash, cash equivalents, and marketable securities position remained relatively flat from the sequential fourth quarter at roughly CA$2 billion. This cash has played an important role in supporting Canopy's aggressive acquisition strategy.
However, upon closer inspection, we find that the CA$245 million Constellation Brands invested into Canopy Growth in May (through exercising warrants the company held) is the only reason the company's cash balance didn't tank further during the quarter. Canopy used CA$118.6 million in cash in operating activities during the quarter, plus saw another CA$61.5 million head out the door for the purchase of property, plant and equipment. That works out to a free cash flow for Q1 2021 of minus CA$180.1 million. Yuck!
Canopy Growth may be the most cash-rich pot stock for now, but it's burned through more than CA$3 billion in cash since closing a CA$5 billion equity investment from Constellation in November 2018.
5. A mountain of goodwill remains
Lastly, Canopy Growth's balance sheet remains an eyesore.
Even though David Klein has suggested that the company will be stepping back from its acquisition-heavy growth strategy for the time being, it doesn't mask the fact that goodwill of CA$1.93 billion accounts for 28% of total assets. Tack on CA$444.2 million in intangible assets and CA$1.51 billion in property, plant and equipment, and I see some very questionable figures that could well require significant impairment charges in the future.
Although writedowns won't impact Canopy Growth's ability to operate, they would significantly reduce the company's total assets and readjust investors' fundamental opinions of the company.
Suffice it to say, Canopy Growth still has a long way to go before it become worthy of your investment dollars.