The gold-rush hype surrounding the cannabis space is no more. But that may not be such an adverse development for those investors looking to enter the cannabis industry for the long run.
Canopy Growth’s Q3 metrics in February came in better than analysts’ expectations. The Street was encouraged by year-over-year revenue growth of 39%. Net revenue was $123.8 million CAD, up from $76.6 million CAD.
However, like many other cannabis producers Canopy Growth has so far not been able to convert the revenue growth into real profits. Per-share loss was 35 cents CAD.
The group has four segments of revenue:
- Canadian Consumer (i.e., retail recreational) – further divided into Business-to-business and Business-to-consumer;
- Canadian Medical;
- International Medical;
- Other: revenue from recent acquisitions including Storz & Bickel GmbH & Co., KG (“Storz & Bickel”), TWP UK Holdings Limited (“This Works”), and BioSteel Sports Nutrition Inc. (“BioSteel”).
Canadian retail recreational remains the most important segment for Canopy Growth as well as its peers. The results showed that the Canadian cannabis sector remains oversupplied. So in the Q4 results, investors would like to see how COVID-19 pandemic may be affecting the supply and demand levels in the country.
Q3 conference call was the first occasion when investors got a better appreciation of the leadership of the new CEO David Klein. He was previously the CFO of the alcoholic beverages giant Constellation Brands (NYSE:STZ). InvestorPlace readers may remember that back in 2018 STZ had paid $4 billion for a 38% stake in Canopy.
Klein highlighted that going forward the group would focus on Canadian operations that would likely continue to bring the majority of the revenue.
Over the past year, a lack of growth in the Canadian recreational segment has meant lower gross margins and higher operating expenses. And Canopy’s cash burn during the quarter was $500 million CAD. Thus it came as no surprise that Klein now aims to optimize the company’s cost structure.
Therefore, when Canopy Growth next reports in the coming days, investors would like to see that his various cost-cutting measures and production cuts are beginning to pay off and that the group has a clear path to profitability and positive cash flow.
Growing Pains and CGC Stock
Cannabis is an agricultural commodity and producing it is capital-intensive. Put another way, Canopy Growth and its peers are operating in an expensive commodity-based consumer market. As a result, marijuana firms, not unlike modern farming businesses, have had to make substantial initial and ongoing investments.
In late 2018, during the early weeks following legalization, Canadians spent about $40 million on legal weed. It was rather easy to dream about the bright future f0r weed stocks like CGC.
However, since then recreational pot sales haven’t really held up. Instead the figures have come in much less robust than initially anticipated. Yet the black market is still thriving in Canada. How can a producer like Canopy Growth maintain high margins in an industry that does not have meaningful growth potential?
Since cannabis is a highly regulated industry, retail licenses are not given out easily. Especially in 2019, the slow rollout of retail stores in major Canadian provinces resulted in lower than expected demand, driving inventory levels higher and profit margins lower for most pot stocks like CGC.
And in 2020, the COVID-19 pandemic brought further headwinds as Canadian retail demand became more volatile under the lockdown. Amid these developments, 2020 has seen Canopy Growth scale down especially its international operations and lay off hundreds of workers.
Stakeholders are also realizing that it is too soon to count on federal legalization to happen in the U.S. And other international sales outside Canada and the U.S. are not big enough to act as a substantial catalyst for the share price of CGC as well as other pot stocks.
As the international expansion dream for pot stocks comes to an end, we are likely to see the industry in Canada to consolidate further and eventually to stabilize. But that may be a rather welcome development for Canopy which has the financial and managerial backing of Constellation Brands.
There is market opportunity in the edibles space as the rollout of Cannabis 2.0 in Canada increases. The group may also be able to increase its retail stores which would likely help increase its strong position among peers.
Where CGC Stock Is Now
This has been a difficult year for marijuana stocks, including CGC. Many of them saw new 52-week lows earlier in March. For example, on March 18, the ETFMG Alternative Harvest ETF (NYSEARCA:MJ), a marijuana-themed exchange-traded fund (ETF), hit an all-time low of $8.81. And YTD, it is down about 30%.
You may remember that about 18 months ago, in Oct. 2018, CGC stock had seen an all-time high near $60. Now, it is hovering at around $16.
Put another way, rich valuations in the sector have taken a hit as the trend of unprofitability has become the norm.
In the coming weeks, I expect CGC stock to trade between $12.5 and $17.5. From a valuation standpoint, the stock is not necessarily a bargain at $12.5, either.
Therefore, if you are already a shareholder who has paper profits since mid-March, then you may want to realize some of these gains.
Alternatively, if you are an experienced investor in the options market, you may also consider using a covered call strategy with approximately a one- or two-month time horizon. An ATM covered call position in CGC stock with June 19 or July 17 expiry would offer you some downside protection. It would also enable you to participate in a potential up move.
The Bottom Line on CGC Stock
For cannabis investors, CGC stock needs little introduction. As we get ready to finish the first half of 2020, is this a great opportunity to buy into the future potential of one of the definite leaders in the Canadian pot space? After all, the stock is much cheaper than it was a year ago.
I would personally like to see the upcoming quarterly results before buying Canopy Growth shares. Revenue growth in itself would not be enough of a fundamental reason to commit fresh capital into the group.
Are the results of the recent substantial moves to restructure the company paying off? If it begins to see profits and a stop to the cash-burn issues, then CGC stock may well deserve to be on your radar screen.
In such a case, I’d be willing to give more time for the efforts of Klein who is likely to take further appropriate decisions that match the realities of the Canadian cannabis market.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.