It was clear and obvious at the time of the firing of Canopy Growth (CGC) co-CEO Bruce Linton, that Constellation Brands wanted the company to start to move toward lowering costs and widening margins. At the time I noted that this would inevitably cause the revenue of the company to decline, and that was confirmed in its latest earnings report.
Even so, the size of the miss for revenue was deeper than I was thinking, and it doesn't bode well for the earnings trajectory of the company when it not only failed to increase sales of oil and softgels, but experienced a disappointing decline in revenue in those important product categories. I'm far more concerned about that than the one-off adjustment it made in relationship to warrants held by Constellation Brands, associated with Canopy Growth buying the rights to acquire U.S.-based Acreage Holdings.
That's exasperated by its unfavorable product mix that is heavily weighted to low-margin recreational pot sold in Canada.
Unsurprisingly, investor sentiment is very negative, with individual portfolios in the TipRanks database showing a net pullback from CGC.
Some Nasty Numbers
The biggest disappointment and surprise in the earnings report of Canopy Growth was its failure to even match the revenue generated in the prior quarter, which also fell short of expectations. Net revenue of C$90.5 million was 4 percent lower sequentially. The market was expecting an increase of 17 percent for the quarter against the previous quarter.
Of that, C$60.8 million of that came from the Canadian dried cannabis recreational pot market, which is a low-margin product. It needs to improve its product mix going forward in order to boost sales while widening margins. If it doesn't accomplish that, it's going to decline far faster than I think it will as the company stands today.
One bright spot in revenue was with medical cannabis sales at the international level, where the company managed to boost net sales from C1.8 million in the previous quarter to C$10.5 million in the reporting period.
On the other hand, the drop in oil and softgel revenue in the first quarter was staggering. It only managed to sell C$0.2 million in the quarter, significantly down from oil and softgel revenue of C$36.5 million in its fiscal fourth quarter.
Part of that was the result of the company making an adjustment concerning oils and softgels estimated product returns, but that was only part of the reason for the decline.
Another concern I have in regard to revenue is the company saying it was the consequence of supply restraints, and yet Aphria (APHA), Cronos (CRON) and Aurora Cannabis (ACB) don't appear to have been hindered by that in the Canadian market to the same level Canopy Growth was. In the case of Aurora Cannabis, I'm assuming its unaudited numbers it released are close to its actual results, as it won't be reporting until September.
Gross margin in the quarter was also dismal, finishing at 15 percent, not even reaching the 16 percent in the prior quarter. Analysts were looking for close to 23 percent.
According to management, the weak gross margin was primarily from C$16.2 million in operating costs associated with production facilities that weren't fully operational in the quarter.
The other factor was the aforementioned disastrous decline in oil and softgel sales, which would have offset some of the low margins related to dry cannabis sales.
After the last couple of weak earnings reports and the debacle surrounding the firing of Bruce Linton, it's apparent to me that Canopy Growth is struggling to find its identity and the way to go forward.
One of the obvious problems to me in the timing of firing Linton was Constellation Brands had nothing in place to replace his vision for growth. That points to there being more problems than are visible to those on the outside. That's why the numbers are bad, even when accounting for adjustments.
For that reason, the assertion by its CEO that it will have an annual revenue run rate of C$1 billion has to be taken with a healthy grain of salt, as the company is going in the wrong direction, and even with it saying CBD and derivative sales should climb in the quarters ahead, it's hard to believe it's going to find a way to generate C$250 million in quarterly sales anytime soon.
That said, it can't do much worse in softgels and oils, so there's really nowhere to go but up, yet the company pointing to weaknesses in demand in the Canadian market against supply, means it'll have to rely heavily on other products to reach its revenue guidance. It don't see that happening within the time frame the company stated.
Investors also have to remember that expectations are there will be a new CEO put in place that is officially approved of by Constellation Brands, which is now essentially in control of Canopy Growth.
How that transition plays out is yet to be determined, and if the new CEO continues on with the strategy being implemented at this time, why is there a need for a new CEO, if that's how it works out?
The truth is, there needs to be a new CEO hired sooner rather than later. As the company stands today, there won't be a sense of stability until that happens. And when it happens, I for one want to know what the real reason for changing management was, and if it is concerning growth as has been stated, than what is the difference in the type of growth instituted by Linton, and the type of growth Constellation Brands wants?
I think the state of flux the company is in now will continue to hinder it from reaching its potential, and if things keep on going as they are, it's going to take a long time for the company to dig itself out of the hole it's now in.