Investors Should Wait to Buy Canopy Growth Stock Until Profits Appear

CGC's operating losses and acquisitions continue to bleed the company’s value

Canopy Growth (NYSE:CGC) stock is still sliding. Since my last article on Sept. 18, CGC stock has fallen over 22%. When I last wrote about the company, I pointed out that the Canopy Growth faced big problems.

The More CGC Stock Flounders, the Less Constellation Can Handle It
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None of these problems have gone away. Canopy Growth stock is set to fall still further.

CGC is still bleeding money. Its adjusted free cash flow losses widened from the prior two quarters — widening to $824 million CAD from a loss of $414 million CAD. This includes the perennial acquisitions that CGC seems to make each quarter.

Canopy Growth Stock Financial Pressures

The bottom line is that the company is running out of money. Although it has $3.1 billion CAD in cash and securities, it used up $158 million CAD in operating losses and $406 million in investing losses in its latest fiscal quarter. This can be seen in the latest cash flow statement below.

Canopy Growth stock Cash flow statement Q1 2020

If CGC spends $564 million each quarter in losses and acquisitions, its cash and securities balances will fall by $2.3 billion CAD in one year. This will bring the cash and securities balances to just $884 million CAD.

At that point, CGC stock will be much lower. Canopy Growth stock has a market value of $7.5 billion, or $10.3 billion CAD. The stock market value includes the value of its cash and securities. With $2.3 billion CAD less in cash and securities, the stock will fall at least 22%, if not more, to $8 billion CAD.

Acquisition Spree May End

Canopy Growth spends a lot on acquisitions. Its latest quarterly report showed that it owns at least five companies with or greater than a 28% stake. It accounts for these using the equity method. That method requires the company to keep the investment on its balance sheet but adjusts for losses incurred on a “see-through” basis.

So far CGC’s equity investments have led to $1.8 billion CAD in losses. These losses have been written down against the investments, not the income statement. Nevertheless, it shows that the money Canopy Growth has spent so far has not led to any significant value for shareholders.

I suspect that as a result, CGC will stop making such large investments as it did in Q1 2020. It spent $403 million on acquisitions of subsidiaries. Canopy Growth cannot keep on doing this without reducing its cash and securities balances further.

Even if CGC cuts out all further acquisitions, its free cash flow is still negative. You can see in the table above that the Q1 losses from operations and capital expenditures totaled $370 million CAD ($158.3 million CAD in operating losses and $211.8 million CAD in capital spending). That works out to free cash flow losses of $1.5 billion CAD annually.

So even without acquisition spending, its normal free cash flow losses will reduce its cash and securities balances by 48% to only $1.7 billion CAD. Canopy Growth stock will fall significantly if that happens.

No Value from its Acquisitions

So far Canopy Growth stock has received no value in its own market price from its large number of acquisitions. L.E.K. Consulting’s Alan Lewis and Dan McKone conducted a famous study on over 2,500 mergers and acquisitions. In a Harvard Business Review article titled “So Many M&A Deals Fail Because Companies Overlook This Simple Strategy,” the authors examined whether or not acquisitions added value to a company. Here is the conclusion they reached:

“As our research has shown us, the core of the problem is not the high number of M&A deals in itself, but rather that too many executives bring insufficient discipline to the evaluation process that fuels these deals — as a result, they often get deals wrong. For instance, despite the importance of accurately identifying and calculating company synergies, diligence work frequently results in an overly optimistic view of the revenue synergy opportunity. Often the weakest assumptions involve estimates of how much additional revenue the companies can generate when combined. This, in turn, leads bidders to overpay.”

It seems that Canopy Growth is guilty of falling for this mistake. It has acquired several companies. CGC clearly overpaid since none of the investments has turned profitable for them on an equity accounting basis. It is also not clear that the stock price really incorporates the value of these investments so far.

Stay Wary Until Profits Shows Up

CGC needs to start showing that it can produce profits on a cash flow basis. CGC stock will continue to fall until it does this. I would wait to buy Canopy Growth stock until proof of profits appears.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks, which includes both dividend and buyback yields. In addition, subscribers a two-week free trial.

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