A severe slowdown in the world economy and an unwillingness to lend to speculative sectors increases the downside risks for Canopy Growth (NYSE:CGC). Even though cannabis firms are reporting record losses and massive write-downs, CGC stock has bounced back a bit, as the stock ended its downtrend and daily closing at new lows recently. This signals the market’s willingness to bet on Canopy Growth thriving as others fail.
Canopy bounced back sharply from its $10 March lows and held the $15 level after posting changes to its global operations.
Management said it will exit Africa, shut down an indoor growing facility in Saskatchewan, Canada, close operations in Latin America, and stop hemp farm operations in Springfield, New York. In effect, the company slimmed-down its global presence to align its supply with weak demand.
CGC Stock Impact of Strategic Moves
Canopy will take a write-down of 700 million CAD ($495 million) to 800 million CAD for the quarter ending March 31, 2020. Sacking 85 people will also lower operating costs, though to a smaller degree. At a smaller size, the cannabis firm is no longer in a growth phase. So, investors should expect unit sales growth to slow and supply growth to do the same.
Since other firms are taking similar steps, the global excess supply of cannabis and hemp should alleviate the pricing pressure that plagued the sector.
Canopy closed its retail stores in Canada amid the general health-related shut-down in the country. Although it has 23 retail Tokyo Smoke and Tweed locations, the closure should not have a material impact on sales. Consumers can purchase Canopy’s products through its Spectrum Therapeutics unit and on the Tweed and Tokyo Smoke e-commerce platforms.
More importantly, expectations of a gradual end to the lock-down will spur investor confidence for the biggest players in the cannabis market. Canopy ended the fiscal year with $1.6 billion in cash. Its net debt position of $1.2 billion represents a steady decline over the last few years.
Stable Product Prices are Key
Cutting operating costs should accelerate Canopy Growth’s path toward a positive operating margin. But investors will need to watch for product prices to stabilize. The company may no longer increase unit sales and total revenue at ever-increasing losses. In the last three fiscal years, free cash flow per share losses grew at a compounded annual growth rate of 220%.
Allowing cannabis sales in such jurisdictions as Colorado, New York, Michigan, and California during the stay-at-home orders may give Canopy’s sales a lift in the current quarter. Also, allowing these companies to stay open signals that the government may support the industry further. Now, investors should look beyond the pandemic and speculate whether consumer demand will strengthen once things normalize.
Consumer demand for cannabis-based products may shift favorably as habits change. For example, by staying at home more often, customers may permanently shift some of their spending from alcohol, tobacco and clothing to cannabis.
Revenue Growth Ahead
Management said that fire sales from competitors hurt pricing and increased supply. CFO Mike Lee told analysts on the Feb. 14 earnings conference call that “we’ve seen examples of aggressive pricing by some competitors, which began in earnest and the back half of the third quarter. And we expect these isolated pricing actions to continue, as our market intelligence suggests that these competitors are focused on freeing up cash from their long inventory positions.”
Conversely, Canopy said that demand for premium, high-THC strain products improved. It benefited from an over-50% growth for its premium flower and pre-roll joints in the third quarter (Q3/2020).
Canopy Growth is still risky speculation but the worst seems to be behind it. Consolidation among the weaker firms will lead to a stable cannabis market. This company is in a good position to grow as competitive pressures lighten up.
Chris Lau, contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.