A new fiscal year is underway for Canopy Growth (CGC -0.89%) -- one that will be full of work and transition, per the company's new CEO David Klein. The Ontario-based cannabis producer is working on beefing up its financials and getting closer to breakeven.
The results for the first quarter of fiscal 2021, released Aug. 10, were a bit mixed. Below, I'll break down the numbers and see just how the company did in Q1. Let's start with the bad news first. Here are four reasons why Canopy Growth's numbers weren't impressive, and why investors may be tempted to ditch the stock:
1. Sales growth was minimal
In Q1, Canopy Growth's net revenue of 110.4 million Canadian dollars was up 22% year over year. However, when compared to the fourth quarter, it rose by just 2.3%. The low level of sales growth, especially during Q4, is concerning because retail cannabis sales have been rising in Canada amid the pandemic. Nationwide, sales jumped from CA$151.9 million in February to more than CA$178 million in each of the next three months, an increase of at least 17%. And yet Canopy Growth barely came away with any growth in its most recent quarterly results, which captured its sales through the end of June. Without stronger sales numbers, it may be difficult for growth investors to buy the stock.
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2. Its gross margin fell below 6%
Making things worse were Canopy Growth's quarterly gross margins, also lower than they were a year ago. Despite a 22% improvement in sales, the company netted a gross margin of just CA$6.5 million -- close to one-third of the CA$18.3 million it recorded in the prior-year period. Just 5.9% of the company's net revenue was remaining in Q1 after covering cost of goods sold. A year ago, that percentage was over 20.2%.
In the earnings release, management said the low margins were because the company has been under-utilizing its facilities, and that it's confident it can get its margins up to over 40%. That will be necessary if management wants any hope of hitting breakeven. And it's hard to justify investing in a company that is barely making enough to cover its cost of goods sold.
3. SG&A is still 123% of net revenue
Canopy Growth did make strides in improving its financials. Selling, general, and administrative (SG&A) expenses of CA$135.4 million were down 7% from the prior-year period. That has come as the company's been laying off staff and cutting overhead wherever it can. Some of the changes likely haven't been reflected in its financial results yet. However, SG&A still accounts for 123% of net revenue, reminding investors of just how far the company still needs to go before it can get anywhere near profitability. Until that number comes down, it's going to be difficult to turn a profit -- or even convince investors that profits are attainable.
4. Purchase of short-term investments could mean more volatility in the future
I'm not a fan of companies burning through cash and using the money they do have on investments. In Q1, Canopy Growth used up CA$118.5 million to fund its day-to-day operating activities. But that number paled in comparison to the CA$382.5 million it spent on the purchase of short-term investments. The company's total short-term investments now come in at CA$1.1 billion.
As cannabis investors know all too well, investments can move sharply in price, and that could create volatility for Canopy Growth. In Q1, it reported a loss of CA$7.2 million relating to equity method investments, worse than the CA$1.8 million it posted a year ago. This is not a huge red flag, but it's still a bit of a concern, especially since management provided no detail about the specific investments they were buying on the earnings call or as part of management discussion and analysis.
It's always a concern for me to see a company move away from its core business and start getting heavily involved in investing and nonoperating activities. Investors should keep an eye on this in future periods, and if it continues to increase, it's a sign that Canopy Growth may be on the wrong path.
The positives
There were two positive numbers from Canopy Growth's Q1 results that are worth noting. First, its total operating expenses showed significant improvement, falling from CA$233 million a year ago to CA$178.9 million. And that's with Canopy Growth incurring CA$12.8 million in impairment and restructuring costs this past quarter. The cost savings helped Canopy Growth record a smaller loss in Q1 of CA$128.3 million compared to a loss of CA$194.1 million in the prior-year period.
The other positive was that, while the company did burn through CA$118.5 million in cash from operating activities in Q1, this was an improvement from CA$158.3 million a year ago. Management has also scaled back on capital purchases, spending just CA$61.5 million this period compared with CA$211.8 million a year ago.
Conserving cash and cutting expenses are good indicators that Canopy Growth is making steps in the right direction.
Is the stock a buy?
There were more negatives on this list than positives. But the negatives pointed out problems that may very well be temporary in nature, or are already familiar to Canopy Growth investors. And so while there may be more reasons to sell the pot stock than to buy it, they're not strong enough to outweigh the positive indications that Canopy Growth is taking real steps in improving its financials.
Year to date, shares of Canopy Growth are down 18%, which is slightly better than the 21% decline the Horizons Marijuana Life Sciences ETF (HMLSF 3.22%) has seen during that time. If Canopy Growth can continue to make progress on improving its operations, it may not be too long before its share price is back into positive territory.
