Canopy Growth (NYSE CGC), along with most other cannabis firms, continues to operate at a loss as it builds out the infrastructure, develops its markets and develops goods that differentiate itself from the competition. Yet so far, pot stock investor seem oblivious to the risks of ongoing losses for the foreseeable future. So before investing in CGC stock, you need to pause for a moment to look at a few metrics. In doing so, investors can confirm that the company is on the right track. With that in mind, how does CGC stock fare for the speculative investor?
Canopy Growth’s yield potential in Canada is a good indicator of the company’s operational efficiency. Much of the profit potential depends on government regulation and the pace at which it approves Canopy’s medical products.
Problems begin when investors look at the company’s efficiency outside of the Canadian region, namely Europe, Australia, and South America. In those places, management does not have a clear estimate on yield over the next 1.5 to 3 years. Denmark has yet to produce supply for Canopy and is not scheduled to do so until later this year.
This is yet another example of investors waiting for production to increase in meaningful quantities. Even if it reaches full utilization on time, investors are hardly assured that revenue from sales will exceed the costs for producing edibles and beverages.
Weak Quarterly Results
Investors reacted negatively to Canopy Growth after it reported results on Feb 27. CGC stock had previously topped $59.25 but now trades near $42 — and for good reason. Revenue of $83 million CAD tripled from last year, but Canopy Growth still lost 38 cents CAD a share. It also missed analyst consensus estimates. The company failed to benefit from average selling prices going up.
The ongoing losses suggest that the company will have to raise prices even more to offset growing losses. If the product is demand elastic, Canopy may have a hard time selling in higher volume when prices are up.
Temporarily non-producing facilities, absorption of the medical excise tax and commitments to sales and marketing and corporate infrastructure spending led to an adjusted EBITDA loss of $75.1 million. However, Canopy Growth is likely to face other one-time charges in the upcoming quarter — so don’t write this off as a one-time issue.
The medical side of Canopy Growth faced some pressure in the third quarter. To counter the headwinds, Spectrum, its wholly owned subsidiary, needs more education-driven activity to grow awareness of the brand and the medical products. On Apr. 12, Spectrum Cannabis announced a partnership with an endorsement from CARP, a Canadian advocacy association for aging Canadians. It will offer tailored educational initiatives for over 320,000 CARP members.
The company continues to believe that its medical opportunity globally over the next three years has a higher growth potential over the recreational market. For this to happen, Canopy therapy would need to face fewer regulatory hurdles than medical marijuana.
Canopy is also running a promising study evaluating the efficacy of medical cannabis for treating insomnia. These tests are currently in Phase IIb clinical trials. It received approval from Health Canada in the second quarter of 2019. Thanks to awareness from the client base for cannabis in its role in helping to fall asleep or stay sleep, Canopy only needs to refine the ingredients and run a number of trials to gain approval from regulators.
Strong Cash Balance
Canopy Growth has a few bright spots. Shareholders may point to the safety of its cash levels as one of those. By looking at Canopy’s $4.9 billion in cash, most of which came from Constellation Brands, Inc. (NYSE: STZ), investors are at least assured that the company will not run out of money any time soon.
Canopy’s inventory build-up is also another positive development. Management intentionally increased inventory from $102 million at the end of March 2018 to $185 million at the end of December 2018. It is scaling up supply to meet strong market demands. As the legalization of the recreational market and medical customers expect more choice, the company expects sales volumes to increase.
The Bottom Line on CGC Stock
The risks in Canopy Growth is typical with any other stock in this sector: losses outpace revenue. The market is willing to wait for output to increase in 2019 but risks remain. Still, the company has lots of cash so short-term risks are low. Plus, as supply facilities are built, its efficiency will get better through scale.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.
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