Canopy Growth (CGC) is a leading cannabis company that produces, distributes, and sells a diverse range of cannabis and hemp-based products, under a portfolio of distinct brands in Canada and internationally.
The company’s core operations are in Canada, the United States, and Germany.
In May 2020, Constellation Brands (STZ), one of the most prominent alcoholic beverage companies in the U.S., raised its equity stake position in Canopy Growth to 38.6% through a C$245-million deal. I am neutral on the stock. (See Analysts’ Top Stocks on TipRanks)
Recent Results
The company’s Q1 2022 results came in rather mixed.
The company delivered a solid top-line performance for the quarter, with revenues growing 23% versus the comparable period last year. Revenue growth was powered primarily by growth in Canadian sales, and excellent market reception in the company’s new products.
If we are to exclude growth derived by Canopy’s acquisitions, revenue growth would still come out 19% higher year-over-year, showcasing strong organic growth.
Due to Canopy’s first-mover advantage and consistent growth, the company has reserved the No. 1 spot in terms of market share in the Canadian recreational cannabis market, despite the increasingly competitive landscape.
Moreover, with the company unlocking economies of scale potential over time, gross margins advanced notably during the quarter as well. They stood at 21%, versus 7% in the prior-year period.
That said, Canopy remains deeply unprofitable. Despite adjusted EBITDA improving from -$92 million to -$64 million year-over-year, Canopy seems to be really struggling to deliver a positive bottom line. Free cash flow was also weak, posting a decline of 3% from -$180 million to -$186 million.
Why the Stock Is Falling
While Canopy has been growing relatively consistently, and Constellation’s equity stake certainly signals creditworthiness and confidence in the company, shares have been declining non-stop year-to-date.
In fact, Canopy is approaching its four-year lows. The rest of its cannabis peers have also been under pressure, which certainly contributed to Canopy’s decline.
However, if we are to identify the primary reason Canopy’s share face such high volatility, it’s the company’s profitability issues. Simply put, the market doubts Canopy can meaningfully grow its EBITDA, and more importantly, net income.
With gross margins that are already too compressed, there is little to no room for juicy profits, so Canopy’s revenue growth alone comes in short.
One could argue that margins should expand along with revenue growth. However, this could hardly be the case, sustainably speaking. The cannabis market is known for being brutally competitive, with no barriers to entry for large corporations.
Hopefully, Canopy will be able to leverage its brand’s power to charge a premium on its products in the long run. Still, this is highly speculative.
In the meantime, as long as Canopy keeps losing money, this is certainly going to lead to the need to raise more cash. Hence, the company will become more indebted (which is going to compress margins further going forward due to growing interest expenses), or shareholders will be further diluted.
In any case, things are not looking that bright in Canopy’s investment case.
Wall Street’s Take
Turning to Wall Street, Canopy Growth has a Hold consensus rating, based on one Buy, eight Holds, and zero Sells assigned in the past three months. At $20.76, the average Canopy Growth price target implies 47.6% upside potential.
Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.
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