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Canopy Growth (CGC): When Will the Horror Show End?

When investors thought Canopy Growth (CGC) couldn’t report any worse numbers, the company shocked the market with another big miss. Digging into the numbers, the underlying trends were better than the headlines, but the leading Canadian cannabis LP has a long way to go before the business is supportive of the current valuation still around $5.2 billion.

Big Charges

The company officially reported FQ2 revenues of C$76.6 million. These revenues were hit by C$32.7 million in restructuring charges from returns and pricing allowances from the softgel and oil inventory and an inventory charge of C$15.9 million.

These combined charges reduced gross margins by C$40.4 million. Without these charges, revenues were up 6% sequentially to C$118.3 million. The increase was entirely due to the boost in International medical revenues from the C3 and ThisWorks acquisitions.

As some competitors had already reported, the Canadian market was a disaster in the quarter due to the expected inventory flood. Canadian B2B recreational revenues were down 15% sequentially and total gross Canadian cannabis revenues were down 7% to C$76.6 million before the charges and excise fees.

Too Much Inventory

For the September quarter, Canopy Growth completed a second quarter where harvests topped 40,000 kg. The problem here is kg sold were only 10,913 kg. The company sold 3% more product in the quarter while the business was built for at least double that product sales level.

Technically, gross margins dipped to negative 13% in the quarter. Absent the adjustments, gross margins were 38% in the quarter. As well, the adjustment includes a C$10.5 million in costs for underutilized facilities.

No matter how one wants to view the revenues and gross margins, Canopy Growth still has costs out of whack with the reality of the business. The company spent an insane C$160.3 million on operating expenses in the quarter, up from C$120.0 million in the June quarter. These expenses don’t even include the C$13.6 million charge for depreciation costs.

The end result is an adjusted EBITDA loss of C$154.7 million, up from what appeared to be a large loss of C$92.0 million in the prior quarter. The end result was another sizable use of cash. Canopy Growth burned C$404.7 million during the quarter from the EBITDA losses and another C$228.3 million for capital spending.

Even down at $15, the stock has a market value of $5.2 billion and quarterly sales in the C$100 million range. The enterprise value is $3.2 billion due to the $2.0 billion cash balance. The market has to carefully weigh the enterprise value considering the sizable cash burn could quickly dissolve this valuable asset.

Analyst Commentary

Canopy Growth is like that driver motoring down the highway with the ever-blinking turn signal. Those following along behind are left wondering if that turn will ever come. Seaport analyst Brett Hundley doesn’t see a turnaround anytime soon. However, the analyst believes investors shouldn't count the embattled pot giant out of the game just yet.

In a research note issued today, Hundley noted, "Thus far during CQ4, industry pricing is weakening further as more supply aims to funnel into a limited store set. This will be a major issue ahead, in our view, to include new 2.0 products. CGC projects that Ontario can potentially open 40 stores per month, starting in January, 2020. This seems overly optimistic [...] The company missed badly on fiscal Q2:20 EBITDA results, and it yanked Q4:20 sales expectations of $250MM while acknowledging current pressures across the marketplace. That said, its balance sheet remains robust, and the company remains well positioned to eventually take advantage of a longer-term reward. We lower EBITDA estimates and remain at Neutral." (To watch Hundley's track record, click here)

Takeaway

The key investor takeaway is that Canopy Growth still needs to reign in global expansion plans to focus on areas where the company can generate positive cash flows. The FQ2 earnings report was horrendous with some sliver of hope due to the improved gross margins outside of the charges and adjustments.

Due to the declining cash balances, investors should view a dip to $10 as very possible. A stock valuation of $3.5 billion makes far more sense considering the current operating losses and struggling revenue picture.

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