Canopy Growth’s (NYSE:CGC) last earnings report missed expectations by a mile, and investors initially rushed to dump Canopy Growth stock. Canopy’s interim CEO, Mark Zekulin, referred to the results as “complicated” and “challenging” in his opening remarks on CGC’s earnings conference call. And when a company starts off a conference call like that, its tone is going to be downbeat.
Zekulin pulled no punches, lobbing blame at the government of the Canadian province of Ontario. Speaking about the Canadian recreational market, Canopy’s leader said that it’s:
“[S]imply not living up to expectations. And at the risk of oversimplifying, the inability of the Ontario government to license retail stores right off the bat has resulted in half of the expected market in Canada simply not existing.”
Even that might understate things; look at the latest data from Canada’s drug regulator. Dried cannabis inventories continue to build much faster than consumer demand. As of August 2019, dried cannabis inventories exceeded 328,000 kilograms, compared to consumption of less than 13,000 kilograms per month. Thus, the Canadian market has more than two years of excess inventory. And for the most part, that figure is growing with each passing month.
In any case, the market wasted no time punishing Canopy Growth stock; it dropped as much as 30% in the two weeks following the latest earnings report. However, the worst may be behind CGC and other marijuana stocks. Canopy and other marijuana stocks have recovered tremendously since their recent earnings-driven plunge. What’s it all mean for Canopy Growth stock?
Making Sense of Canopy’s Latest Earnings Report
Canopy’s headline earnings numbers seem to indicate that things are really bad for CGC. The company’s revenue not only came up way short of analysts’ average estimate, but its bottom line was also way below analysts’ mean forecast.
Not all of that was pure operating losses, however. Management decided to bite the bullet and write down a large chunk of CGC’s cannabis inventory.
Much of the writedown was based on the value of products such as CBD softgel tablets and oils. It turns out that consumer demand has strongly skewed toward cannabis-flower-based products rather than medicinal extracts. Canopy has lost tens of millions of dollars as a result of its misguided decision to emphasize such products.
Rivals such as Aurora (NYSE:ACB) produced a much smaller number of these extract-based products and thus have taken less of a hit from them.
CGC can correctly argue that there will be bumps in the road for any new emerging industry. Assuming that inventory writeoffs will not be a recurring problem for Canopy Growth stock and that CGC’s upcoming launch of new cannabis products such as drinks will move the needle for CGC stock, this earnings report could have been the bottom as far as the company’s operating results go.
When Will the Outlook of Canopy Growth Stock Improve?
Canopy’s CEO recently noted that there is only one marijuana retail location per 600,000 residents of Ontario. That’s obviously not enough and largely explains the continued prevalence of black-market marijuana in large portions of the Canadian recreational market. CGC believes that Ontario is now set to open up the marijuana store licensing process to all applicants. That should finally allow stores to catch up to demand.
In Prince Edward Island, a small province with a large per-capita store base, sales are roughly three times as high per capita as in all of Canada, according to data from the regulator.
Thus, if Canada eventually reaches Prince Edward Island’s levels of consumption, the recreational market would enjoy a robust recovery. Notably, Canopy is the market share leader on the island.
For those investors who believe that the Canadian recreational market will rebound in 2020, Canopy Growth stock is still an obvious pick. CGC says it’s still the market share leader in numerous other, larger provinces including Alberta and Ontario, and it’s in second place in Quebec, trailing only Hexo (NYSE:HEXO).
Another important point is that CGC has its own stores. As the problems in Ontario show, controlling the supply chain can be a big advantage. If companies don’t have strong retail channels, their whole business plans can fail.
And to Canopy’s credit, the sales growth of their stores accelerated meaningfully last quarter, despite the highly challenging operating environment. In addition, Canopy’s cash position and partnership with Constellation (NYSE:STZ) give it more staying power than most of its rivals.
The Verdict on Canopy Growth Stock
CGC issued a ton of press releases in November. It announced a new joint venture with mega-successful rapper Drake. CGC launched a promotional partnership with a luxury fashion brand, and it trumpeted the successful licensing of its new beverages line.
Canopy is looking to advertise that it’s doing a great deal right now. But investors have wised up to these sorts of promotional moves.
At this point, investors are demanding better actual operating results from marijuana producers, including Canopy. It’s not enough to talk about things that could happen in the future anymore; as long as these cannabis companies keep burning cash, marijuana stocks won’t be going much higher.
The legalization of cannabis drinks and foods has a lot of potential. Who knows how big the market will be for these products?
Canopy is also researching other cannabis derivatives, such as skin care, creams, and bath products. These products could boost marijuana stocks tremendously.
There’s no rush to buy CGC stock at this point, though. Investors are in wait-and-see mode until cannabis companies deliver concrete results. Investors will have plenty of time to buy marijuana stocks, including Canopy Growth stock, in 2020 if green shoots start emerging within the industry.
At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.