Canopy Growth's (CGC 2.41%) stock is on fire, with its shares gaining 214% in the last 30 days despite its decline of 45% this year so far. The marijuana company's fortunes, battered badly by the cannabis market collapse of North America and its own inefficiency, could be finally starting to turn around.
But it's no secret that cannabis cultivators like Canopy have burned investors badly more than once, and there's reason to believe that some of the industry's traditional pitfalls are still very much in play. So is this stock worth a buy right now in hopes that its hot streak continues, or is it a trap for investors that's soon to close?
What's driving the surge?
There are a couple of positive developments driving Canopy's bull run. First, in late August, the Department of Health and Human Services (HHS) officially recommended to the Drug Enforcement Agency (DEA) that marijuana should be rescheduled from Schedule I to Schedule III, even though cannabis legalization in the U.S. is still uncertain. If it agrees with HHS, marijuana will become more widely accessible for medicinal use.
Given the company's ongoing plan to pivot toward the U.S. market and away from its home market of Canada, it's no surprise why the market is reacting so favorably to the news. Still, even if the DEA does what investors are hoping, it might not actually result in cannabis producers making more revenue in states that have already legalized recreational cannabis for adults, as those markets won't be directly affected by the change. But there are other factors in play right now, too.
On Sept. 14, it announced that it would no longer allocate any resources to its BioSteel sports beverage subsidiary, which is insolvent despite steadily increasing its sales volume. Since late last year, it sought to sell BioSteel, but had trouble finding buyers due to the subsidiary's outstanding debts of 366 million Canadian dollars plus interest fees. If it eventually succeeds in offloading BioSteel, it'll be positive for the stock, as according to management the beverage business was to blame for roughly 60% of Canopy's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) losses in the first quarter of its fiscal 2024.
What's more, the company has reduced its debt load by CA$349 million since July, and it also notched a total of CA$172 million in cost reductions since the start of its 2023 fiscal year. Further progress on its turnaround plan could deliver another set of cost reductions to the tune of up to CA$310 million its selling, general, and administrative (SG&A) expenses as well as its cost of goods sold (COGS) by the end of the 2024 fiscal year. For reference, it burned CA$576 million in cash over the last 12 months, so if management can deliver on those cuts, it'd go a long way toward making the business cash-flow-positive.
It's still a risky bet
Positive developments and cost-cutting progress aside, there are a handful of reasons to pump the brakes rather than rushing to buy this stock.
The segment it's trying to sell off, BioSteel, is by far its fastest growing, with its sales rising by 137% year over year to reach CA$32 million as of the first quarter of fiscal year 2024, ended June 30, 2023. The runner-up segment is its Storz & Bickel vaporizer hardware brand, worth CA$18 million in the first quarter, which only expanded by 16% compared to a year prior. Its cannabis revenue shrank in practically every market, and its top line of CA$403 million for fiscal 2023 was 21% smaller than the prior year.
Furthermore, its quarterly gross profit margin is still significantly narrower than it was three years ago, and its quarterly COGS is still increasing as a percentage of revenue in the same period. In other words, the cost-savings campaign touted by management has yet to actually reduce core production costs such that the company's overall economic picture improves. When it comes to red flags, spending time and resources on a turnaround plan that doesn't deliver results is a big one.
Although slashing inefficient business units and trimming costs are positive moves, they don't make up for dwindling revenue and an acute lack of profitability that won't be solved anytime soon. So, you probably shouldn't buy Canopy Growth stock right now. Even if you're willing to accept the risks, there are probably better investments out there at the moment.
