Canopy Growth (NYSE:CGC) stock has not shown a dramatic move since its recent quarterly conference call, which laid out lackluster guidance and performance during the fourth quarter of fiscal year 2019. There are some positives from the earnings reports, though. Canopy achieved 76% revenue growth year-over-year ending March 2020, reduced cash burn and will be working aggressively to scale down their operations due to falling wholesale prices.
Chief Financial Officer Mike Lee said the company made dramatic moves to address the realities of their financial situation. They are reducing production capacity 40% in Canada by closing both their greenhouses. The company is also ended their hemp farming operation in New York, and will transition to a “asset-light model” in Columbia.
Canopy is in about 15 markets, and will exit those over time. Adjusted gross margins were 42%, after excluding one-time restructuring and inventory costs. Additionally, the amount of cash they have as of the end of March was close to 2 billion CAD.
The Path Forward for CGC Stock
According to CEO David Klein, executing by meeting customer shifting demand will be the key to creating value for CGC stock shareholders. Canopy stated that Canada, U.S., and Germany will be the focus, and admits that their effort to be the first to market was not a winning strategy. Post-COVID, they hope to get back on track to increase their retail footprint in Canada, and to rotate more in-demand, higher quality product.
Overall, CGC stock will need to earn business away from the illicit market to continue its rise. However, that is a problem. During Q4 2019, the average price for a gram from legal sources was $10.30, while the average illegal price was $5.73. This is a major difference difference.
Moreover, since Canada places strict guidelines on marketing — making it difficult to differentiate products and thus command a higher price. That said, it might be worth looking at the industry just like every other agricultural business: as a commodity business.
However, with almost every agricultural commodity on the planet, governments work to manage pricing by either creating a floor or ceiling based on the prerogatives of their country. This is loosely done with cannabis, and it is apparent that existing barriers are not helping to maintain adequate prices.
Microeconomics theory would say that in a completely competitive market, where products cannot be differentiated, prices tend to follow Long-run average cost, over the long-run, turns to zero. And when prices are higher than cost, new producers enter, which brings prices down over time.
To create an ability for businesses to survive, governments apply quotas, fees or anything that would reduce production and new entrants. This can work for legal businesses, but doesn’t work for illegal ones. Stores are easy to regulate, but it is nearly impossible to stop all growers of a crop that can grow almost anywhere.
I’ll look at two examples, so bear with me.
To create price floors over the years, agriculture producers would claim national security interests, jobs or both as a catalyst to lobby the government to manage an otherwise competitive market.
During the 1890s and early 1900s, the predecessor of Domino — the American Sugar Refining Company — fought off monopoly implications for one reason: necessity. In the former instance, the American Sugar Refining Company promised to maintain prices at a lower rate, and that consolidation in the industry would support this goal. In the latter, World War II shortages created a reason to ignore its dominance in the market.
Next, the second example is wheat. In the case of wheat, production limits were imposed and still imposed in the post-World War II era, and exist to this day. Over the last 30 years, even though yields on wheat have increased 25%, production has been managed down 17%. Prices have been allowed to rise, though, allowing American wheat farming to be sustainable.
In both examples, the overall population received something in return. And although we can debate whether it was worth the externalities created by inexpensive carbohydrates, the share of disposable personal income spent on food in the U.S. fell — making it a politically palpable arrangement. In 1960, the average family spent about 20% of their disposable income on food, while today that has been cut in half.
Collectively, the $30-billion question is: who is going to make the case to the Canadian or American people that allowing monopolies — or further restricting production — and thus, keeping price higher — is in their nation’s best interest!? It’s hard to see anyone fight for actions that would raise prices, especially among those who would want to see marijuana legalization.
The Bottom Line on CGC Stock
For the reasons stated above, barring the introduction of a global marijuana pricing control mechanism, (perhaps an appointed self-regulatory organization that governs production capacity under the guise of ensuring safety, quality and standards) I don’t see a bottom on wholesale marijuana prices coming anytime soon. If nothing else, decriminalization will come with higher demand, offset by even more higher-quality entrants and supply.
Supply guts has not stopped investors from speculating. Since mid-May, the stock has been up more than 10%.
I could be completely wrong, and only time will tell what will happen over the long-run. But with $2 billion in cash in its war chest, Canopy Growth may win the war of attrition that has brought down lesser players. However, it will be a long road ahead to profitability either way.
As of this writing, Emmanuel Henson did not hold a position in any of the aforementioned securities.