With almost another month more to go before its next quarterly earnings report, Canopy Growth (NYSE:CGC) may keep trading at new lows. The company no longer has the benefit of speculators bidding blindly for cannabis stocks. Its last quarterly earnings report, posted on Aug. 14, missed analyst consensus estimates on earnings and revenue. Should investors take the risk of betting on the euphoria for cannabis stocks to come back? Or might investors want to sit out from holding CGC stock until the company proves its buildout will translate to profits?
Before speculating on a Canopy stock price rebound, investors must first understand why the company is exciting. Canopy is a multi-billion dollar company by market capitalization — and it is building a business for the next several years. CGC operates in many countries and has 5 million square feet of capacity, plus licensed capacity. Added together, Canopy is ready to supply the market to meet demand. But the near-term challenge is hurting investor confidence not just in CGC stock, but in the sector.
In Canada, Canopy is unable to meet demand due to limited storefronts. Another problem is falling prices. Add the CDC’s warnings for e-cigarette risks and suddenly Canopy’s reliance on so-called Cannabis 2.0 for growth is uncertain.
Canopy’s new CFO said that its near-term priorities include focusing on making sure the company is positioned for Cannabis 2.0. Vape products, CBD beverages and edibles are a big catalyst for revenue growth. But as Americans continue to question the safety of vaping, investors are right in selling CGC stock. The market is lowering the company’s market cap and valuation to price in further risks ahead. Beverages and edibles may not get government approvals fast enough. Health agencies may take more time investigating the safety of derivative products.
Canopy Growth’s Goals
Canopy set a $1 billion revenue rate but is still short of that target. In the fiscal first quarter, net revenue was $90.5 million CAD. Its adjusted EBITDA of negative $92 million CAD also shook investor confidence. But to get to that set revenue rate, the company needs to invest in enterprise resource planning software to handle its global expansion ambitions. Clearly, back-end operations may take more time before it is ready.
Stagnating growth is also a near-term headwind for Canopy stock, as the August report indicated. With growth falling behind its peers, the company is losing its competitive edge, pressuring investors to look elsewhere. Still, Aurora Cannabis (NYSE:ACB) and Cronos Group (NASDAQ:CRON) are both underperforming.
Pressure on Gross Margins
Canopy started retrofitting its facility rooms last year in September. Its facilities were not harvesting as much as the company wanted. This disrupted output for the last few quarters and led to the company missing expectations. But once the overhead work is completed, the negative impact on gross margins will ease.
In the last three quarters, Canopy’s gross margins came in at 15%-22%. Once the retrofitting activities are completed, expect the levels to return to the high 40% range once again. With Cannabis 2.0, the company forecasts a 200-300 basis point productivity increase. This should add meaningfully to margins.
Conservative investors should keep their eye on the existing business. Canada had around 460 stores and should get to 600 by the end of the year. If the industry, which includes Canopy, is able to supply to retail channels, Canopy should start seeing revenue acceleration. It will probably still report losses as the company faces startup costs for Cannabis 2.0.
My Takeaway on CGC
Canopy is a growth hope story that markets are unwilling to speculate on at this time. But the stock has hopeful investors who are not selling yet. The growth thesis is achievable but will take a few years to play out. The sector still also needs cannabis legalization to happen not only in Canada but in other major markets. If that happens, then the sector could pay off for investors buying CGC stock.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.