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Canopy (CGC) Earnings Fell 59% – So Why Is It a Buy?

Canopy Growth (CGC), Canada’s largest cannabis company, reported fiscal Q1 earnings on August 14, and the results were anything but growth-oriented. At the same time, the company reports that production and product stockpiles are up, and at least one analyst has just upgraded CGC from Neutral to Buy. Let’s look at recent events with Canopy, and figure out what’s going on.

A Disappointing First Quarter

There’s no other way to say it: Canopy’s Q1 disappointed investors. Net revenue was reported at C$90.5 million, down a whopping 60% from Q4’s C$226 million. Just as bad, the reported earnings missed the C$109 million forecast by 17%.

Lower revenues meant lower earnings. Everyone knew that Canopy would report a net loss for Q1, but the magnitude of the loss, C$3.70 per share, was a stunner, far worse than the expected 38 cents. A large part of the quarterly loss, however, came from a one-time write-down of warrant liability related to the terms under which Constellation Brands acquired its 35% stake in the company.

Bad news kept coming in, however. The quarterly gross margin of 15% was lower than Q4’s 16%.

On the management side, Canopy is still coping with the termination of founder and co-CEO Bruce Linton two months ago. Linton’s forced departure, prompted by top stakeholder Constellation, left his business partner, Mark Zekulin, as sole CEO. The company issued a statement, however, that “A search has commended to identify Mr. Zekulin’s replacement as the company’s Chief Executive Officer.” While not necessarily bad news, the ongoing churn in top management continues to be a red flag for investors.

A Spot of Hope

There was some good news in the quarterly report. Production was up, and the company has plenty of product in stock. Canopy reported a total harvest of 40,960 kilograms, a more than four-fold increase from the year-ago quarter, and sales of 10,549 kilograms, for a sequential quarterly sales gain of 12.6%. Canopy’s largest sales category was dry recreational cannabis, at 7,673 kilograms. The balance was sold in a variety of medical categories.

The high production and sales numbers put Canopy in a strong position to expected demand increases going forward as the Canadian market legalizes edibles and vaping products. After the Q1 revenue drop, this bodes well for Canopy in the mid-term.

Management is putting the happy face on, as expected. In his statement on the earnings and company’s prospects going forward, Zekulin said, “Fiscal 2020 is going to be another exciting time for the cannabis industry as we close in on the launch of new product formats. Our recent harvests are proof that our focus on operational excellence is working, and we look forward to showing both our Canadian and U.S. customers what we’ve been working on behind the scenes to prepare for the next wave of products coming later this year.”

A Plunge in the Markets

Investors have not been impressed. CGC shares fell 14.3% in the immediate aftermath of the quarterly report on August 14. Since then, shares have fallen an additional 7% and have levelled out in the last three trading sessions.

Canopy is a major player in the cannabis industry and the largest cannabis company in Canada, with a market cap of US$8.7 billion, so a performance like this – a quarterly whiff and a plunge in share price – is sure to attract attention from Wall Street’s top analysts. And it has. No fewer than a dozen analysts have reviewed Canopy since the Q1 release.

Hearing from the Analysts

Predictably, several analysts have rated Canopy as Hold, while even the bullish reviewers have lowered their price targets. But one analyst has upgraded Canopy, seeing the current dip as a buying opportunity for a company with strong prospects going forward.

Seaport’s Brett Hundley moved his rating from Neutral to Buy, saying, “… cannabis has been a risk-off trade to this point, and the Street has had to reset growth and profit expectations for the space and Canopy…” He added that analysts and investors cannot expect dollar-for-dollar value on Canopy’s cash flow going forward; “…it will likely be multiplicative.” Hundley is conservative with his price target, setting it at $31 for a 23% upside potential.

Writing from PI Financial, 5-star analyst Jason Zandberg reminded investors that much of Canopy’s loss in Q1 was of a one-time nature, and that the company has a firm foundation going forward. He also noted that international medical sales “improved significantly from $1.8 million last quarter to $10.5 million.” Zandberg gives CGC a Buy rating, although he declines to set a specific price target.

Vivien Azer from Cowen, a 5-star analyst and a long-time expert in the legal cannabis industry, was disarmingly frank in her comments: “[Canopy] published a disappointing 1Q20. Revenue declined sequentially, and now trails APHA and ACB, and gross margin deteriorated sequentially, off of what had been already been depressed levels in 4Q19… the company does not expect to reach profitability until at least FY22. The saving grace here is STZ’s involvement.” Despite all of that, she sees Canopy a stock to buy, and sets a $36 price target suggesting room for an impressive 44% upside.

Overall, even after the disappointing quarterly showing, Canopy retains a Moderate Buy from the analyst consensus. Shares are selling for $25, the average price target is $41, and the upside potential is a hefty 67%. (See CGC’s price targets and analyst ratings on TipRanks)

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