After a somewhat disappointing earnings report and the accompanying commentary from management, it’s apparent to me that Canopy Growth (CGC) is struggling to find its corporate identity and a consistent business model.
It surprisingly generated less revenue from recreational and Canadian medical cannabis in the quarter, while at the same time delivered $34 million in other revenue; that tied into diversification of its revenue streams, one of the most positive parts of its performance in the quarter.
Taking into account the rapidly changing cannabis industry and Canopy considering itself primarily a recreational pot producer, it’s apparent the company is struggling to find its identity in a market that isn’t going to favor those with heavy exposure to recreational pot because of that segment descending rapidly into a commodity.
Including oils, edibles and infused drinks, it’s still going to be hard to differentiate from competitors, even though they will produce wider margins.
In its recently released earnings report, Canopy reported fourth quarter revenue of C$94.1 million, a slight beat of C$0.41M. That was up from the C$83 million in revenue generated in the prior quarter.
Some changes in revenue are worthy of note. First, sales from recreational pot dropped sequentially from C$71.6 million to C$68.9 million.
Net losses in the quarter were huge, ending down C$323.4 million, or 98 cents a share, from a loss of C$54.4 million year-over-year. Some of that was a paper loss of C$130 million in relationship to accounting for the increase in its share price and its convertible debt. Even so, it still has C$174.5 million operational losses, far more than its peers.
For the year, net revenue jumped to C$226.3 million, up 191 percent. Breaking it down, C$140.5 million of that came from recreational pot, and C$78.9 million from medical cannabis, up 6 percent year-over-year. Canadian medical revenue ended the year at C$68.8 million, down from C$70.6 million from fiscal 2018.
Of importance was Canadian medical revenue in the reporting period dropped to C$11.6 million, a hefty decline from C$19.5 million in the fourth quarter of fiscal 2018. The company attributed that to transferring some medical products to its recreational unit.
Internationally, medical revenue climbed to C$10.1 million for all of fiscal 2019, up 173 percent from full-year 2018. The main catalyst there was the German market, followed by the Czech and Polish markets.
Going forward its Other sales should become a larger percentage of overall revenue, as evidenced by the acquisition of Storz & Bickel in the third quarter. That helped push Other revenue to C$34 million for the fiscal year, an average of a little over C$2.8 million per month. That should be included in performance models in the future.
The core business problem and capital allocation
In my view one of the major problems Canopy Growth has is it must determine what its core business actually is. It started off as a recreational pot company serving the Canadian market, yet having branched off into just about every other area of the cannabis sector, it hasn’t been very effective in markets outside of Canada.
It’s obvious that Canopy will have to transition out of recreational pot being its primary business, as it won’t be too long before it becomes a commodity product. That means competing primarily on price, which isn’t a viable or sustainable long-term strategy.
As the company is attempting to make the adjustments needed to change it product mix going forward, it appears it hasn’t decided yet what it core business is. That’s crucial to the company because the priority associated with the allocation of capital is dependent on knowing what the core business is, and making operational decisions in alignment with that.
For example, in the last quarter Aurora Cannabis could have sold more recreational pot, but it stated it held back some of its inventory to ensure it would have enough to service its medical segment. That wasn’t a difficult decision because Aurora has clearly stated its core business is medical pot.
With Canopy not seemingly in the process of determining what its core business is, it has brought about some problems in major international markets, especially Germany.
Outside of the U.S., at this time Germany is the major market to compete in, and Canopy has struggled to make it work. The company said in its earnings report that it didn’t have enough of the product Germany required to that market.
Also in regard to Germany, there were inventory storage capacity restraints that will limit the future exports to the market as well. Didn’t the company think this through before going into the market? It should have been very obvious.
The point is, I believe this is partially because the company is not fully focused on any one segment because of its lack of clarity concerning its core. This lack of clarity I believe comes from the understanding it has to make the transition from recreational pot to other segments in order to be profitable over the long term, or even survive. This is something money alone can’t buy.
Another related issue in my opinion is the company having so much underutilized capacity. Since it keeps mentioning its cash infusion from Constellation Brands as a competitive advantage, how hard can it be to allocate a little capital to growing more pot in its existing facilities?
These types of things suggest to me management is distracted, and again, I think much of that distraction is coming from not knowing or defining what its core business is, and making decisions and allocating capital in alignment with that.
The issue at hand isn’t that Canopy Growth is trying to compete in various segments of the cannabis market, all cannabis companies that will grow and survive will have to do that. The issue is the company appears to be disjointed because it isn’t working from a defined core business base, and making decisions based upon that.
It has said its goal is to primarily bring its business operations to a high level in Canada and then scale it out to other markets. The problem is that’s not a core business, that’s a strategy.
The market needs to know exactly what Canopy Growth is in order to be able to understand better how it’s going to perform in the future. That will determine allocation of capital how and why the company will prioritize its decisions.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.
Disclosure: No position.