Why is it that Canadian pot companies are struggling while revenue is soaring for their peers in the U.S., where marijuana is not even federally legal?
Firstly, Canada is a much smaller market than the U.S. With a population of just under 39 million, it's comparable to California. Secondly, regulatory hold-ups delayed the opening of cannabis stores in many provinces. In addition, some Canadian pot companies' errors have left them in distress.
As a result, cannabis players like Aurora Cannabis (ACB -3.55%), and Canopy Growth (CGC -0.66%) -- which were popular with investors for many years -- have failed miserably and consistently to report positive adjusted earnings in the last two years. Yet these companies keep making promises on the subject every quarter.
Most Canadian pot companies sabotaged themselves. Aurora Cannabis, in particular, went on an acquisition spree that overburdened its balance sheet. When it failed to grow revenue to match its boosted production capacity, it had to shut down most of its larger grow facilities -- a process it called "cost rationalization." And it did help Aurora to some extent in managing expenses. In its fiscal 2022 second quarter (which ended Dec. 31), Aurora realized annualized run-rate cost savings of 60 million Canadian dollars, and it expects to hit its original savings target of CA$80 million by the first half of fiscal 2023.
Canopy, on the other hand, played it smart by securing a strong partner to do some of the financial heavy lifting. Alcoholic beverage giant Constellation Brands first invested in the company in 2018 and now holds a 38% stake in it. Canopy also adopted some cost-cutting measures, and according to management, it realized cost savings of CA$85 million by the end of its fiscal 2022 third quarter (which also ended Dec. 31).
Though Canopy is safe for now from financial danger, it too has failed to either grow revenues or transition to profitability.
In its fiscal third quarter, its net revenue dropped by 8% year over year to CA$141 million. As a result, it recorded an adjusted EBITDA loss of CA$67 million -- not much of an improvement from its loss of CA$68 million in the prior-year period.
Aurora has failed to achieve its EBITDA targets repeatedly since last year -- unsurprising, since its revenues declined. For example, they dropped 10% year over year to CA$60 million in fiscal Q2.
But its cost-cutting measures did help the company reduce its EBITDA losses from CA$80 million in Q2 fiscal 2020 to CA$9 million in Q2 fiscal 2022.
Recently, Aurora announced that is acquiring Ontario-based Thrive Cannabis. Management said it expects to be EBITDA positive in the first half of fiscal 2023 through this acquisition. However, it's still soon to say if this deal will be beneficial to Aurora, as mergers and acquisitions take time to reveal their full potential.
Its history of missing its bottom-line guidance targets makes it hard to trust that Aurora will be able to achieve profitability any time soon.
Unlike Aurora, Canopy has no current forecast for when it will achieve positive EBITDA. But Canopy's management has high hopes for the U.S. cannabis market, which could be a long shot. If and when federal legalization happens, domestic cannabis companies would be the first to benefit. Instead, Canopy should focus on boosting revenues in Canada or in international markets where it already has a strong presence.
This is not the year for these pot stocks
These companies' recent earnings reports do not give any indications as to whether they are doing anything to change their current circumstances. Further, Canopy's management warned that it expects some COVID-related headwinds in Europe and Canada to affect its results for the current quarter.
Wall Street analysts have high hopes for both Canopy and Aurora this year. Their consensus price targets anticipate upsides of 57% and 46%, respectively. But I believe that it's out of the question that either will reach profitability this year, and regardless of the schedule, it won't happen until they grow their revenue significantly.
I would therefore advise investors to steer clear of these stocks until they show some robust growth numbers. Aurora is a risky bet, but Canopy, with its strong partners, has good prospects in the U.S. a few years down the line. Investors who are already invested in Canopy should hold onto their shares for the long haul. Those still interested in making new investments in Canadian pot stocks should consider Tilray, which is proving to be a much stronger company in the wake of the merger with Aphria, and is also profitable.