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2 Reasons I Still Have Faith in Canopy Growth

By Sushree Mohanty – Aug 22, 2020 at 7:25AM

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First-quarter results were gloomy, but there's a light at the end of the tunnel for the cannabis giant.

The marijuana sector hasn't lost too much steam in the face of the coronavirus pandemic. Sales are on the rise as cannabis products behave more like consumer goods --  demand has been regular and reliable. Some U.S. cannabis companies have even managed to achieve profitability from bumps in revenue. Their Canadian counterparts, however, have yet to achieve this, facing growth an illicit cannabis market, regulatory delays, and other roadblocks. One such pot company is Canada-based Canopy Growth (CGC 4.57%), which boasts the industry's largest market cap of $6.2 billion. 

Results from its fiscal first quarter of 2021, which ended June 30, didn't tell the story investors were hoping for. Canopy's shares have fallen about 24% so far this year, in tandem with the Horizons Marijuana Life Sciences ETF. Canopy took cost-cutting measures to reduce cash burn during the quarter, but they weren't enough to turn a profit. 

But we should keep an eye on the bright side. The first quarter wasn't all bad -- there are a few factors keeping the hope alive for Canopy. 

Marijuana beverages and edibles.

Image source: Getty Images.

First, the tough news from Q1

Canopy Growth made its name in the cannabis space after Canada legalized medical marijuana. Medical marijuana was technically legalized in 2001, but Canada's federal courts only meaningfully liberated the market in 2016. Canopy's popular marijuana products are sold there under brand names like Tweed, Tokyo Smoke, and Spectrum Therapeutics. After its fourth-quarter 2020 results failed to impress, hopes were high for these products in the first quarter of 2021.

Year-over-year revenue for the first quarter grew 22% to 110 million Canadian dollars. This was only a 2% increase from Q4 2020. Upticks in medical-marijuana sales in Canada and Germany likely constitute the boosts. The benefits of its C3 business, acquired in April 2019, and This Works, acquired in May 2019, were also reflected in the quarter. But once you exclude the sales from these acquisitions, net sales growth was a mere 9%. 

Investors should also note the recreational sales dip in Canopy Growth's home country. Canadian recreational net revenue slumped 11% to CA$44.2 million, which the company attributed to challenges in the retail environment amid the coronavirus pandemic. Meanwhile, international medical marijuana revenue showed robust growth by 92% to CA$20.2 million from the year-prior period.

An adjusted EBITDA rang in at CA$92 million compared to CA$93 million in the year-ago quarter. EBITDA is an important measure of profitability, which implies how well a company is handling its operating expenses. Despite reducing total operating expenses by 23% to CA$178 million, Canopy's EBITDA losses continued.

Canopy Growth isn't alone in its struggles. Peer Aurora Cannabis (ACB -0.75%) is also trying to reduce its operating expenses to achieve positive EBITDA by the first quarter of fiscal 2021. Cost-cutting measures include closing down unprofitable facilities and shifting capital toward profitable ones. We will know more about how its strategies have played out when the company releases earnings on Sept. 25.

ACB Chart

ACB data by YCharts

The good news on cash positioning

Canopy highlighted its good cash position at the end of Q1, with CA$2 billion in cash, cash equivalents, and marketable securities. Its cash position was protected because Constellation Brands (STZ 0.31%) exercised its warrants in May, investing another CA$245 million in the company. Both companies agreed on a strategic partnership with an initial investment of CA$245 million in October 2017. In November 2018, Constellation invested another CA$5 billion in Canopy Growth, which has helped the company continue to maintain its aggressive acquisition strategy. Canopy's management believes its Canadian business does not require additional cultivation assets, and expects to do more of its spending on its American business.  

Constellation's increased stake in Canopy Growth is a sign that the beverage giant has faith in the company's profitability potential. Constellation's support is also one of the reasons why Canopy has been able to survive the ups and downs the industry faced last year, which included a slump in revenue, regulatory delays, and black-market challenges. The financial backup should help Canopy battle through the rest of the year.

A businessman pushes a boulder uphill.

Image source: Getty Images.

The even better news on Canopy's expanding markets

Canopy's endeavors to establish a footprint in the U.S. CBD (cannabidiol) market are also commendable. The U.S. hemp-derived CBD market could grow to $1.3 billion by 2022, according to estimates by New Frontier Data. The Farm Bill legalized all CBD products derived from hemp that contain no more than 0.3% tetrahydrocannabinol (THC) in Dec. 2018. However, marijuana is still illegal under federal law.

Canopy is working with retailers to expand the distribution of ready-to-drink non-CBD hydration sports drinks in key U.S. markets. Canopy purchased a 72% stake in BioSteel Sports Nutrition Company, a nutritional company popular with some American athletes, in October 2019. BioSteel recently earned a key partnership with the Brooklyn Nets and was duly dubbed, "The Official Sports Drink of Barclays Center."

Another positive in the quarterly results is the burgeoning potential of Canopy's cannabis derivatives products. This category includes vapes, edibles, concentrates, and beverages. These types of products were legalized in October 2019 as part of "Cannabis 2.0" legalization, which expanded the list of forms of recreational marijuana that could be brought to market. Just before Q1, Canopy launched a variety of vape products, chocolates, and cannabis-infused beverages. These recreational derivatives products alone contributed to 13% of total Canada business-to-business sales in Q1.

Despite the supply challenges faced during the pandemic, Canopy has shipped over 1.2 million cannabis beverage units since late March. The products included four THC-infused ready-to-drink beverage lines under the Tweed, Houseplant, and Deep Space brands. These high-margin products could be vital to the company's long-term growth. Management expects them to help push Canopy's gross margin past 40%.

These moves point to Canopy becoming the top cannabis beverage company in Canada. Constellation Brands' market presence should also help expand distribution and boost sales for beverage products. The New York-based company has built its reputation through its Corona Extra and Modelo beers as well as wine and spirit-based drinks.

Canopy Growth's cost-cutting efforts, growth strategies, innovative derivative products, and financial partner in Constellation Brands could help the company recover in 2020. If the estimates for the growth of cannabis products are correct, it could -- that's right, could -- achieve profitability in the near future. 

Sushree Mohanty 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 Corp. Stock Quote
Canopy Growth Corp.
$3.66 (4.57%) $0.16
Constellation Brands Stock Quote
Constellation Brands
$257.49 (0.31%) $0.80
Aurora Cannabis Inc. Stock Quote
Aurora Cannabis Inc.
$1.32 (-0.75%) $0.01

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