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Canopy Growth Needs to Keep Cash High in Order to Survive

Struggling investments in cannabis-infused beverages and chocolates threaten CGC's cash stash

These are tough times in the marijuana patch.

Source: Shutterstock

Legalization is moving slowly. The edibles, vapes and drinks business, called Cannabis 2.0, isn’t looking great either.

This means people are taking my long-standing advice to walk away from the space. Shares in Canopy Growth (NYSE:CGC), the market leader thanks to Constellation Brands’ (NYSE:STZ) backing, are down almost 10% since the start of 2020. This loss erased an early January rally.

Even at its Feb. 11 opening price of $18.90, Canopy remains an expensive stock. The market capitalization of $6.8 billion is about 20 times anticipated 2019 sales of $340 million. This assumes Canopy makes the December “whisper number” of $79.2 million in revenue.

Dave’s Now Here

Constellation sent its chief financial officer, David Klein, in to fix Canopy as its new CEO. He started work Jan. 14. Constellation owns 38% of the stock.

He walked into a disaster. Actually, he walked into a series of disasters.

Previous management under Mark Zekulin had touted a full line of beverages in press tours late last year. Klein had to put off the launch.

Zekulin had also touted a line of chocolates, made in an old Hershey’s (NYSE:HSY) factory. But the point of a pot-infused chocolate bar isn’t to enjoy premium chocolate. The bars Canopy turned out are not competitive with illicit products, which offer almost 40 times the potency at just 1.5 times the price.

Vaping, once touted as the answer to smoking’s health problems, is now also in a bad odor.

The whole point of Cannabis 2.0 was that Cannabis 1.0, the business of selling previously illegal weed legally, isn’t working out.

While pot is now legal in many places, authorities aren’t letting companies open many stores. They also mandate prices that can’t compete with illegal weed, which is indistinguishable from the legal stuff. The government is saving money on enforcement, not investing money in supporting a legal market.

The result is that Klein is growing too much pot and has a lot of worthless manufacturing capacity.

A Bullish Thesis

The January pop in the shares came when a single analyst, Tamy Chen of BMO Capital Markets, decided to raise her rating on Canopy from “neutral” to “outperform.” Her thesis was that a shakeout is coming, with less-capitalized players in need of new financing. Canopy’s cash stash, $2.7 billion at the end of September, means it can survive the shakeout.

The most important number analysts can see in Canopy’s Feb. 14 report, then, will be in the balance sheet. It will be the cash number. Canopy burned through about $400 million in its September quarter. If it hits estimates of a 36 cents per share loss, that would be a cash burn of just $125 million.

Unfortunately, given the investment in chocolate and beverages, the burn will likely be greater. The hope then becomes that Klein can limit the burn going forward.

The Bottom Line on CGC Stock

It’s possible that Klein can right-size Canopy and build a profitable business.

But it’s also likely that the business isn’t nearly as large as analysts once assumed.

Even if marijuana is made legal throughout the U.S., it will still be tightly regulated. We now know that regulators aren’t friends of the legal pot business. This means illegal growers will continue to retain most of the market, even in Canada.

It turned out making marijuana legal was just a first step. Making it competitive is the second step, and it’s one that may be beyond even Constellation Brands’ ability.

Dana Blankenhorn is a financial and technology journalist. He is the author of the environmental thriller Bridget O’Flynn and the Bear, available at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story. 


Article printed from InvestorPlace Media, https://investorplace.com/2020/02/canopy-growth-needs-to-keep-cash-high-in-order-to-survive/.

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