Cannabis investors have lost billions of dollars in 2019. The optimism witnessed in October 2018, when recreational use of marijuana products was legalized in Canada, seems a lifetime away. Pot stocks were decimated in 2019 due to sky-high valuations, a slow rollout of cannabis retail stores, vaping scandals, rising inventory levels, falling profits, and much more.
Shares of Canopy Growth (TSX:WEED)(NYSE:CGC) have fallen almost 30% since the start of 2019. However, it is trading 65% below its 52-week high. Have marijuana stocks bottomed out? Will they move higher in 2020, or will the carnage continue to drive shares lower?
The backing of Constellation Brands will help in the long run
Canopy Growth has the backing of one of the largest companies in the brewery space. In June 2018, Constellation Brands invested $4 billion in Canopy Growth for a 38% stake. In December 2019, Canopy Growth appointed David Klein as company CEO; Klein has served in several management positions (including CFO) with Constellation Brands. It looks like Constellation Brands is going all-in with its investment in Canada’s leading pot company.
In the last reported quarter (ending in September), Canopy Growth reported a net loss of $374.6 million, while the net loss in the June quarter stood at a massive $1.28 billion. While the losses were attributed to warrant adjustments by the investment of Constellation Brands in the fiscal first quarter of 2020 (year ending in March), there are concerns regarding stock-based compensation that accounted for 33% of the company’s operating loss in Q2.
One of the reasons why Canopy founder and ex-CEO Bruce Linton was asked to leave was the company’s rising losses. Now with Klein at the helm, Canopy is expected to be more prudent with its spending. Despite the mounting losses, Canopy ended the September quarter with $2.75 billion in cash, which again reflects the importance of the investment by Constellation Brands.
The verdict
As cannabis is a highly regulated industry, the rollout of retail stores will take longer than expected. But the advent of Cannabis 2.0 products might provide an opportunity for Canopy Growth and peers to increase the top line at a rapid pace. Similar to other pot companies, Canopy has also invested heavily in Cannabis 2.0. It has a product portfolio that includes 13 cannabis-infused drinks as well as cannabis-infused chocolate products.
Last month, the Ontario government announced plans to significantly increase the number of retail cannabis stores. Ontario is one of the key provinces for pot companies, and this move should help the latter reduce inventory levels, which will also boost profit margins.
Ontario will now allow licensed producers to open retail stores at their production facilities. According to the recently released directive, operators will be able to own 75 stores in September 2021, up from 10 stores in August 2020. Ontario had just 24 retail cannabis stores at the end of 2019. This suggests that one store could potentially served 600,000 residents in the province.
Canopy Growth will continue to post losses in the near future. Analysts expect the company’s EBITDA to fall from -$257 million in fiscal 2019 to -$454 million in 2020. This number is estimated at -$248 million in 2021 and -56.6 million in 2022.
Canopy Growth has invested in capital expenditures (capex). In fiscal 2019, it spent $644 million in capex, while this figure is estimated to reach $727 million in 2020. This investment has increased due to the company’s expansion of Cannabis 2.0 products. However, Canopy’s capex might fall to $283 million in 2022, which will boost its free cash flow metrics significantly.
While the cannabis sector will continue to be impacted by structural issues in 2020, Canopy Growth is better placed than most to ride the volatile environment. Its huge size and, more importantly, the support of Constellation Brands, might help the stock rise from the ashes sooner rather than later.
