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All Eyes on Canopy Growth (CGC) Ahead of Earnings

When a couple of major Canadian cannabis players announce major cost restructurings, Canopy Growth (CGC) has to be the next major to make the move. The new CEO has already pushed out the key cog of the company's Cannabis 2.0 products, as THC beverages weren’t ready to scale. The next move for the company has to be a restructuring of a large operation generating large losses.

Canopy is sure to provide more details when it releases its fiscal third-quarter earnings report, which is scheduled for tomorrow before the market open.

Competitors Restructuring

Last week, both Aurora Cannabis and Tilray announced major cost cuts. While Aurora Cannabis cut 25% of their corporate staff and Tilray cut 10%, the biggest concern for Canopy was the revenue guidance of Aurora.

The Canadian cannabis industry giant forecast more weak sales in the December quarter, but most importantly guided towards no sales improvement in the March quarter. After Canopy reported several quarters with EBITDA losses in the C$90 million range, the lack of a sales improvement is highly problematic.

Analysts forecast Canopy growing March quarter revenue by nearly 25% sequentially with no logical conclusion this will occur now. Not only are Cannabis 2.0 products likely to fail due to the lack of Ontario stores and vapes banned in Alberta and Quebec, but also Canopy still hasn’t released THC beverages due to issues with scaling the beverage products in production.

Without product returns and pricing revisions in FQ2, Canopy had net revenues of C$109 million before pricing adjustments and product returns. The revenues were slightly up from the prior quarter, but both quarters generated EBITDA losses in excess of C$90 million.

The addition of the Cannabis 2.0 products without the associated revenues could potentially position Canopy for an even larger EBITDA loss in FQ3.

Cost Cutting Must

The scary part of the story for Canopy is that Aurora Cannabis had a much smaller operating expense base, yet the company still felt the need to cut costs by nearly 60% from the December quarter level. The company is going from a quarterly expense level of C$100 million to somewhere capped at C$45 million.

For FQ2, Canopy had adjusted operating expenses at C$160 million, or nearly double the spending level of Aurora Cannabis in the September quarter. The launch of Cannabis 2.0 products in Canada and CBD in the U.S. has to have pushed these costs substantially higher again.

Canopy has the cash balance of C$2.7 billion to possibly grab some market share in markets where Aurora Cannabis and competitors are cutting costs, but the company still needs to rationalize costs. The cannabis giant can’t lose over C$100 million a quarter while still spending on capital expenses without watching the cash cushion suddenly disappear from chasing bad markets.

Consensus Verdict

Wall Street almost evenly split between the bulls and those choosing to play it safe. Based on 15 analysts polled in the last 3 months, 7 rate Canopy stock a Buy, while 8 issue a Hold. The 12-month average price target stands at $21.55, which implies nearly 10% upside from current levels. (See Canopy stock analysis on TipRanks)

Takeaway

The key investor takeaway is that Canopy has likely run into more hurdles with meeting financial targets. The stock is far too expensive with a valuation of $7 billion while revenue estimates for FY21 ending March are going to slip below $500 million.

Investors have no valid reason to pay over 14x forward sales for a stock struggling to grow profitably. Canopy has a need to restructure the business dramatically to cut the operating cash burn before the stock is investable.

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