What a wild time to be in the market. With the legalization of cannabis for recreational purposes in Canada, continued acceptance on the global stage for it, and with even the US becoming more tolerant of the plant and its byproducts through recent legislation that has essentially legalized industrial hemp, this is a fascinating time to be investing and to be involved in the cannabis space specifically. This is even more true after news broke that Canopy Growth Corp. (CGC), the undisputed leader in the space, recorded some really interesting financial results for the third quarter of its 2019 fiscal year. Based on what management had to demonstrate, it appears clear that not only is the firm still the major market leader, it’s likely to remain that way for the foreseeable future, a situation that could, over time, create real value for shareholders.
Unless otherwise stated (and only then on a case-by-case basis), all references to ‘$’ or dollars will be references to Canadian dollars.
Growth is explosive… but there are caveats
It’s rare to see a multi-billion dollar company where you can claim that growth is truly explosive. Canopy is one such case. During its third quarter, which was the first quarter (but not full quarter) where cannabis was legal in Canada for recreational purposes, revenue for the business skyrocketed 282% on a net basis from $21.7 million in the third quarter of its 2018 fiscal year to the $83 million the company generated in the third quarter of its 2019 fiscal year. On a gross basis, sales were actually even higher at $97.7 million, but management is required to pay excise taxes on what it sells. Total cannabis shipped amounted to 10,102kg during the quarter.
This surge in revenue for the firm came in the form of recreational sales. During the quarter, the company sold 8,287kg (kilograms) of cannabis for recreational purposes. This was up from nothing the same time a year earlier. According to management, 33% of revenue for the firm came from sales tied in one way or another to oils. This was up from just 23% in its 2018 fiscal year. The company continues to focus on the recreational space by producing and selling oils, softgels, oral cannabis sprays, and pre-rolled joints. In particular, the oils and softgels have significant uses in the medical space.
In the recreational area, Canopy had some interesting results that I would not have expected. When I think ‘recreational,’ I think of business-to-consumer sales more than business to business, but what management disclosed was that of the 8,287kg shipped (which accounted for 82% of the firm’s volume for the quarter) that fell under recreational, 7,381kg fell under business-to-business sales. Though this may sound insignificant to some, the fact of the matter is that business-to-business sales are low-margin in nature compared to alternative sales.
The good news from this, though, is that it still leaves a great deal of upside for Canopy moving forward. According to management, during the quarter, the company had only 10 Tweed store locations opened that are company-owned, plus 1 Tweed store that is licensed, and it had only 4 Tokyo Smoke locations resulting from its acquisition of HIKU during the second quarter. Though management did not indicate a timeline for this in its earnings release or the resulting conference call, they said that they plan to open 20 more of each brand in the near future. Assuming they approach the situation appropriately, it should result in a very robust uptick in sales in the months to come. Given that rival Green Growth Brands (OTCQB:GGBXF) said that between March of this year and the end of this year that it will open 108 new locations, I can’t imagine Canopy not being able to open these 40 stores by the end of 2019 at the latest.
Another great development for Canopy during the quarter related to pricing. While a lot of its sales were low-margin in nature, with recreational cannabis selling for $6.96 per gram (with no prior-year figure to compare it to), sales prices actually rose year-over-year for its other categories, unlike in the case with rival Aurora Cannabis (ACB). According to management, the average selling price for medical cannabis in its home market of Canada totaled $9.77 per gram, up from $8.21 per gram a year earlier. International medical prices rose from $12.61 per gram in the third quarter of 2018 to $13.28 per gram in the third quarter of its current fiscal year. This kind of movement is great to see and will likely continue as management strengthens its IP (intellectual property) position and expands further into the cannabis market through consumables and other premium offerings.
The final robust development I saw related to cash on hand. In the third quarter, the company closed its $5 billion investment from Constellation Brands (STZ). This is great, but with significant investments being made, I was curious just how much of this cash would remain on the firm’s balance sheet. Well, as of the end of the quarter, Canopy had a sizable balance of $4.915 billion, up from just $429 million one quarter earlier. This suggests that Canopy has, very possibly, years of runway still. What management will do with this capital is uncertain at this time, but we do know that after making a $100 million to $150 million commitment to invest in New York’s growing industrial hemp market earlier this year, the company’s CEO said that the business will go on to invest $500 million in total by expanding its industrial hemp operations to between two and three other states in the near future.
Not everything was great though
On the whole, I applaud the management team at Canopy because I believe that not only did the firm have a knock-out quarter, I believe that management is making some great decisions on how to invest what capital it currently has. However, one dark spot for the firm was on the medical front. During the quarter, while average selling prices were higher, the business shipped only 1,815kg, down from the 2,330kg seen a year earlier. On the international front, shipments grew materially, but in Canada the firm experienced pain.
Some of this appears to be due to cannibalization due to recreational cannabis coming into play, but another factor includes Canada’s excise tax (which management said the company decided to absorb for customers). In the long run, management believes this is a temporary soft spot, with actual upside in medical (especially on the global stage) being material as countries that legalize cannabis typically do so on a medical basis first. Because of this and because international sales prices rose, I’m not too worried on this front right now, but investors should keep in mind this softness today and watch in subsequent quarters to see how management’s expectations work out.
By pretty much every measure, Canopy had an excellent quarter that investors should be pleased by. The firm demonstrated tremendous revenue growth, experienced nice upside on the recreational side, and posted nice evidence of strong pricing power. There was some softness on the domestic side of medical, but based on management’s own guidance, the larger picture for medical is looking up in the long run. All of these developments taken together, especially when considering the future retail growth planned for the firm, makes me bullish on the firm conceptually. I have little doubt at this time that if current trends persist, Canopy will remain at the head of the pack in its space for the foreseeable future.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.