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Will Growth Solve the Problem at Canopy Growth (CGC)?

Over the course of a few months, Canopy Growth (CGC) has gone from market darling to a cannabis company with an uncertain future. The focus on being a global leader is coming at a high cost, but the solution that rewards shareholders could well be the predicted market growth mixed with a bit of cost controls.

Non-Stop Spending

So far, Canopy Growth has spent wildly without any real return on those investments. The company has aggressively built up technologies for processing cannabis whether pre-roll joints or vape devices for a patent portfolio of 110 patents and 270 pending applications.

The big question is whether patents are any more meaningful in the cannabis sector as with most other new technologies. Consumers appear rather happy with illegal products and the quarterly results show no signs of Canopy Growth obtaining benefits from vast research expenses.

For the quarter, the company spent C$8.5 million on R&D, up nearly 1,000% from last FQ1. One way to turnaround the business from a massive C$92 million EBITDA loss is to restrain spending growth on R&D.

Normalized Margins

The biggest area where Canopy Growth needs to improve is gross margins. Most industry companies are running in the 50% gross margin range while Canopy Growth is down at an absurdly low 15% in the June quarter.

The company didn’t meet the original C$1 billion annual revenue target set forth by the ex-CEO, but the new goal has Canopy Growth on the path to meet the C$1 billion annual runrate by the end of this FY next March.

The amount suggests quarterly revenues will reach C$250 million or roughly 175% above the C$91 million in FQ1. The number isn’t so impressive when the company only suggests the Canadian operations reach EBITDA positive during FY21 and on a company wide basis in FY22, up to three years from now.

Investors are probably wide aware that fellow competitor Aurora Cannabis (ACB) is on pace for breakeven EBITDA numbers now.

Basic math would have 50% gross margins generating C$125 million in gross profit by the end of this FY. FQ1 operating expenses were already up at C$116 million so Canopy Growth isn’t going to be able to further buildout global operations and the CBD business in the U.S. without substantial additional spending. At this point, Canopy Growth has the potential to turnaround the business, but the company needs far too much to go right in order to reach these breakeven goals with only basic business rationalization.

Takeaway

The key investor takeaway is that Canopy Growth needs to stop having overly ambitious plans. The Canadian cannabis company has the path towards higher revenues and gross margins needed to dig out of these large losses, but also the company needs a new CEO to rationalize the global scale of the business.

The company remains worthy of a watch list, but a market valuation of $10 billion is far too expensive for the goal of annualized revenue that amounts to $750 million a few quarters from now. Canopy Growth has done a lot on R&D and branding that an investor will want to keep the stock on a watchlist for when the company actually turns the ship.

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Disclosure: No position.