The release of second-quarter fiscal 2020 results yesterday felt a little like Canopy Growth’s (TSX:WEED)(NYSECGC) day of reckoning in a long list of days that have felt the same. Canopy Growth stock is down approximately 15% at the time of writing on the day of the release. That’s pretty brutal and feels like a wake-up call.
Let’s take a look at why the market is reacting so negatively to the quarterly results.
Revenue falls 15%
Compared to the prior quarter, revenue declined 15%. This includes a restructuring charge of $32.7 million for “returns, return provisions, and pricing allowances primarily related to its softgel and oil portfolio.” Even without this charge, quarter-over-quarter revenue growth was anemic at 6%. This is a far cry from the type of revenue-growth rates that the market has come to expect and has priced into the stock. To make matters worse, the company recorded a write-off of excess inventory totaling $15.9 million, as it is not immune to the fact that there is a lot of excess inventory, and this has caused a drop in selling prices.
Pricing pressure hits the cannabis industry
As an indication of the pricing pressure that we are now seeing in the industry, we can look to competitors Tilray and Cronos Group, which both reported sharp drops in selling prices this week.
Tilray reported a net loss of US$35.7 million — worse than the net loss of US$18.7 million last year — and its average selling price per gram was just $3.25 — a 30% drop from last year. Likewise, Cronos Group reported a 42% drop in its per gram price to $3.75. These are pretty brutal numbers. Accordingly, Tilray stock is down 71.5% year to date, and Cronos Group stock is down 41% year to date.
As we know, the entire cannabis industry has been suffering in the last year and more so in the last few months, as inventory levels got too high and retail store openings have been far below expectations. I guess with expectations having gotten so high, the only way was to disappointment. The lesson here, in my mind, remains this: with new, emerging industries we need to exercise caution. The cannabis industry today is rapidly emerging, and while it promises to be a very lucrative one, these are early days that are fraught with risk and uncertainty. Investors need to know this before taking the plunge and investing in these stocks to chase big gains.
Profitability is still elusive for Canopy Growth
Moving down the income statement to earnings, we are faced with yet another big disappointment. The company’s net loss per share came in at $1.08, also below expectations. While there is increasing excitement about Cannabis 2.0 being the industry’s saviour due to higher prices and margins that come with these products. If our experience with the cannabis sector has taught us anything, it would be to exercise caution, as this emerging industry will not experience a straight and easy path forward. Cannabis stocks are therefore highly volatile.
Foolish bottom line
We can easily see how these results have yet again been a big disappointment to investors. Given what Canopy Growth stock was factoring into its valuation, it is not surprising that the stock is being hit so hard. Longer term, getting marijuana stocks’ valuations down to more realistic levels is essential in making this group a group of stocks suitable for a more significant portion of investors. Canopy Growth stock’s price-to-sales multiple is below 30 times at this point compared to over 100 times just a year ago. That’s better, but right now, the cannabis sector remains a high-risk one that leaves many of us on the sidelines.
