Many cannabis companies are reporting their quarterly results in November. And for investors, it can sometimes be difficult to interpret the numbers as cannabis earnings reports are often littered with adjustments and gains or losses, making it challenging to determine whether the company really had a good quarter.
But there are some ways you can quickly scan beyond just how the company did on its top and bottom lines to see whether there are any problems you need to be paying close attention to. Here are three words you don't want to see come up on an earnings report or call.
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Impairment
Impairment charges or write-downs are, unfortunately, common on many earnings reports in the cannabis industry. And while it is excluded from adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) calculations, that doesn't mean investors should ignore it. That's because an impairment charge or write-down means that an asset's value on the balance sheet is incorrect or has changed.
An example of this is when inventory values may need to be written down because products have been sitting too long, and the business no longer believes it can sell them for what it previously did. It may not be so forthcoming about the reason, but it's a problem nonetheless, especially when impairment is recurring.
Cannabis producer Canopy Growth (CGC -0.66%) is notorious for often reporting impairment charges on its financials. In its latest results, for the period ending Sept. 30, it reported asset impairment and restructuring costs of 2.5 million Canadian dollars. Though that's an improvement from the CA$46 million it reported on that line item a year ago. But when looking over the last six months, that total rises to CA$81 million versus CA$59 million during the same period last year. In fiscal 2021 (which ended on March 31), the company's asset impairment and restructuring costs were CA$534 million -- nearly as high as its ret revenue of CA$547 million.
Unsurprisingly, Canopy Growth hasn't been a great investment over the past year, falling 43% while the S&P 500 rose by 34%.
Warrants
Another word that investors should be fearful of is "warrants" because that can be synonymous with dilution. A warrant allows someone to buy more shares at a predefined price. And the more warrants a company has out there, the more potential there is for a flood of shares to hit the market as the stock rises in value.
This one can be trickier because warrants may not show up on a company's press release announcing earnings. However, you can find reference to them in the actual earnings report where the company discloses the value of warrants, as well as their exercise prices. The exercise price is key because if someone is holding a warrant and the price of a stock surges above that value, then the warrant is in the money, and there's an incentive to use it to buy shares of the stock (assuming, of course, there are no restrictions to doing so).
I was surprised by how many times I saw "warrants" on cannabis producer Sundial Growers earnings report for the period ending June 30 -- there were 100 references. Keeping track of all the different types of warrants and rules relating to their exercise can be quite complicated. That's why an easy rule here is that if it's too complex and difficult to do so, it's probably best to steer clear of the stock, as it could be nothing more than a dilution machine.
Although Sundial Growers' stock is up 177% over the past year, that was largely driven by the meme stock craze at the start of the year. Since the end of January, its shares have fallen 15%, while the S&P 500 has risen by 26%.
Compression
The most amusing word on earnings reports to me is "compression." It reminds me of realtors who describe a small home as "cozy" instead of just saying it is small. Although it sounds nicer, it doesn't change the reality.
You might see "price compression" mentioned on an earnings report, which is a nicer way of saying that the company has reduced its prices. In an industry where margins are tight and profits are hard to come by, it's not a term that investors want to see, as it means that a company's bottom line is deteriorating or will fall in the future.
In Canopy Growth's second-quarter results, the company blamed worsening gross margins during the period, in part, on "price compression in the Canadian recreational business." The company's gross margin in the quarter was a negative 54% (compared to a positive 19% a year earlier). Even after factoring out noncash charges, including write-downs, the margin still would have been a modest 12% of revenue this past quarter. That doesn't leave much of a chance for the company to get out of the red; Canopy Growth recorded an adjusted EBITDA loss of CA$163 million for the quarter, which was nearly double the CA$86 million loss it incurred a year earlier.
And with no word that the "compression" problem is going away, investors can expect to see poor margins in the future.
