Canopy Growth (NYSE:CGC) has been on a tear since the Canadian cannabis grower reported fiscal third-quarter results on Friday, Feb. 14. The rally in CGC stock has been fueled by a lower-than-expected loss and commentary from management that it’s looking to cut costs in a bid to become profitable.
Reining in costs is integral for any cannabis company and one that can draw favor from investors, assuming the initiatives are properly executed. because, as a University of Maryland study notes, “many cannabis companies are small and lacking in financial strength, and efficient management and operation.”
“Typically their costs are not carefully monitored and budgeted,” according to the Maryland researchers.
To be sure, the 11.5% gained by CGC stock over the past week does qualify as a relief rally, one that has some beleaguered shareholders likely saying, “you’ve got to start somewhere.” Fair points to be sure, but cannabis companies, Canopy included, still face myriad issues.
The company is pledging to boost margins while paring equity compensation, which could help reduce dilution. But it could take a couple of quarters for those efforts to really bear fruit and be rewarded by investors.
Cash and Inventory Concerns
At the end of the most recently completed quarter, Canopy had $1.17 billion in cash equivalents. While that sounds decent, that’s down from $1.87 billion at the end of the first quarter of 2019. That’s a not a strong look at a time when analysts and investors are increasingly concerned about cash burn rates in the marijuana space.
Another issue for Canopy – one some market observers believe was overlooked following the most recent earnings update – is that company has produced far more marijuana than it has sold.
“Assuming Canopy ceased all growing operations and maintained current market share, it would take [about] 2.5 years to sell this product in Canada,” MKM Partners analyst Bill Kirk said in a recent note to clients.
Carrying too much inventory is almost universally a bad idea, regardless of industry. In Canopy’s case, Kirk believes the company may be forced to dramatically pare prices – something it is loathe to do – to whittle down its excess stock. It’s a vicious circle: holding too much inventory ties up a company’s cash and Canopy remains cash flow negative, a trait not lost on analysts despite the recent pop in the stock.
A Texas A&M study on retailers’ inventory trends may hold some clues about the risks of cannabis firms holding too much product.
“Small retailers experience a reduction in efficiency when increasing inventory leanness before large retailers do,” according to the Texas A&M research.
As just a $7.64 billion company, Canopy likely lacks the scale that would afford a larger operation luxury of carry excess product.
Bottom Line on CGC Stock
Underscoring the point that there are an array of challenges facing cannabis producers, it’s not a stretch to say Canopy is one of the better names to own for adventurous investors. It’s in an echelon that excludes the likes of Aurora Cannabis (NYSE:ACB) and Tilray (NASDAQ:TLRY), just to name a pair.
If Canopy can effectively cut costs, realize 40% margins and take advantage of marijuana derivatives and infused products in Canada when that market is fully operational, there may be some hope for the stock. But that’s also a lot of moving parts.
As of this writing, Todd Shriber did not own any of the aforementioned securities. He has been an InvestorPlace contributor since 2014.