Canopy Growth – Heavyweight Champion of the World

The Global Cannabis Leader Remains in Top Place

The first cannabis company to list on the CSE, the TSVX and finally, the TSE. The first company to be valued at $100m. The first to be valued at a billion. They were the first to buy out another cannabis company and the first pure-play cannabis producer to list on the NYSE.

The first to get a significant investment from one of the Big alcohol, tobacco and pharmaceutical companies, and the clear and undisputed market leader in all areas of measurement, including revenue, grams shipped, number of active patients and finally, the number of supply agreements with the Canadian Provinces.

Canopy Growth is the undisputed market leader, and hence every time they deliver an earnings report, could almost be considered a barometer for the growth of the global cannabis industry, although we have written before that we don't believe any cannabis company today has that type of gravitas. Still, analysts evaluate with a fine tooth comb.

Some analysts considered the results a mixed bag, but on the whole there is no doubt that one of the strongest management teams in market delivered another stellar quarter of significant growth, not only on home soil but across multiple continents, including opening their account  in the biggest market on the planet – the US cannabis industry.

The American Cannabis Industry

America's green rush is finally beginning to take hold. There are 33 states that now allow medicinal cannabis, while 11 have legalised it for recreational use. The industry—which presently employs more than 250,000 people—saw an explosion of growth over the last twelve months, resulting in the total number of active marijuana licenses in the US […]

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Having said that, the company continues to burn cash at an alarming rate.

However, given they are currently in a hyperbolic growth stage, looking to plant a flag in every corner of the planet, this burn can be forgiven. Although, at some point in the future, they are going to have to demonstrate a pathway to profitability.


Q4 and fiscal year ended March 31, 2019


Canopy delivered industry-leading revenue of just over $94 million for the Quarter, which was slightly above analyst's expectations, rising 312% from the corresponding quarter last year, with quarter-on-quarter growth of 13.2%. A slower quarter of growth was to be expected as a result ion the Canadian recreational market not growing at analysts estimates given the lack of supply and lack of brick-and-mortar stores in the most populous cities.

Canopy, like Aurora Cannabis, does a great job of breaking down their revenue across the recreation, medicinal and international markets, which really gives a clear sense of the company's current focus.

Recreational Cannabis

Canopy is the market leader in the recreational cannabis space in Canada. In their previous quarter, Canopy reported that recreational cannabis accounted for approximately 75% of their revenue. In this quarter, recreational sales feel around 4% to $68.9 million. As we mentioned above, the drop was expected, as most of the Canadian LP's have shown relatively stagnant growth in their recreational sales, and Canada has struggled to get going.

As good as these numbers are, it is a potential future problem for Canopy, as they will only be able to maintain this kind if market leading status in the short-term, following which most of the larger LP's will have significantly increased their production capacity, and in doing so, will claw back some of the early mover advantages that Canopy created through larger production capacity and better stockpiling if inventory for the recreational market.

During the March quarter, Canopy Growth sold 6,964-kilogram equivalents of recreational cannabis, and in doing so, captured approximately 25% market share in the Canadian recreational cannabis market. Aiding this growth has been the opening of a total of 23 retail locations over the 2019 fiscal year under its Tweed and Tokyo Smoke brands.


Medical Cannabis

As solid as their recreational sales were, the opposite could be said of their medicinal sales. Medical cannabis sales to the Canadian market dropped 41% from the third quarter to the fourth quarter's $11.6 million. The official reasons given on the earnings call was due to a product transition.

Basically, Canopy stopped selling their Tweed, DNA Genetics, LBS and certain CraftGrow brands to their medicinal patients, and rather used these to service the recreational market, while transitioning to Spectrum Cannabis for its medical patients.

"Following the re-brand of Spectrum Cannabis, Canopy Health Innovations and C3 into a singular medically-focused division Spectrum Therapeutics, along with increasing finished goods inventory levels, and corresponding price adjustments of select products, the Company believes that Canadian medical sales under the Spectrum Therapeutics brand will be able to return to previous levels of market-leading customer registrations and sales."

Canopy's revenue from international medical marijuana sales almost tripled year on year to over $10 million. What's more, the selling price per gram increased from CAD$13.35 in Q4 2017 to C$13.91 per gram in this quarter.  But the category's gross revenue of $1.6 million in the Q4 fell 25% year-on-year. Canopy stated that "European sales were negatively impacted by supply challenges in Canada, with the company prioritising its Canadian customers."


Additional Revenue

On a positive note, sales of Storz & Bickel vaporiser devices, along with revenue from other strategic sources including extraction services, and clinic partners, resulted in $34 million in other revenue generated in fiscal 2019 giving the sale line a little cream on top.


Gross margins

Canopy has seen its gross margins steadily declining over the past couple of quarters and this quarter was no different.  The undisputed market leader now boasts the worst grass margins of any of its peers.

According to the company, the primary reason for the declining margin has been the underutilisation of its production facilities and its various expansion projects. This quarter, this amounted to around CAD$24 million, which resulted in a gross margin of only 16%, down from 34% in the corresponding period from the prior year, and 22% in the previous quarter.

"Q4 incurred some non-recurring costs related to an unusual weather event and other one-time activities. We expect these facilities to be fully operational in the months ahead, resulting in a return to normalised operating costs for our cultivation facilities." 

If we exclude Canopy's $24 million in operating expenses for facilities not yet cultivating, the company would have delivered gross margins of 41%. This puts it in a much better company if one considers the rest of the LP's. We are not too concerned about this for the moment, as Canopy has been significantly increasing its production capacity and when these facilities do come online, we expect to see a much healthier gross margin.


Still burning man

Once again, Canopy Growth reported a fourth-quarter loss from operations. This quarters loss of CAD$174.4 million was 11% bigger than the CAD$157.2 loss in the previous quarter, and a whopping 240% higher than the CAD$51 million loss in the corresponding quarter last year.

The net loss for the quarter of CAD$323.4 million resulted in earnings per share of  (CAD$0.98) which significantly missed analysts estimates by (CAD$0.66). This compares to a net loss of CAD$54.4 million or (CAD$0.31) per share for the corresponding period last year.

We are not too concerned over this loss for two reasons. The first (and most important) is simply that Canopy is on an aggressive global gland grab to ensure to try and future proof their market leading status for the foreseeable future.

In the latest market report released by BDS Analytics, suggested that legal cannabis sales would grow from US$11 billion in 2018 to US$40 billion in 2024, including a US$5 billion cannabis market in Canada. Moreover, they predicted a compound annual growth rate of around 27% over the coming years. No other industry on the planet is growing at this rate.


Secondly, post Constellation Brand's investment late last year, they still have a war chest of nearly CAD$4.5 billion.  Even if the burn rose to CAD$200 million per quarter, Canopy would still have at least 5 years runway.

We do not expect Canopy to continue to burn cash at such levels however, as they are aggressively expanding their harvest. Canopy doubled its harvest size from the fiscal third quarter of 2019 to the fiscal fourth quarter of 2019, and it expects to do so again as it moves from the fourth quarter to the first.


Outdoor Licenses

On June 24, the company announced that it had received a new licence from Health Canada permitting it to grow cannabis at an outdoor site in northern Saskatchewan. The new licence expands Canopy Growth's diversified Canadian footprint and complements its existing indoor and greenhouse facilities.

Low cost, outdoor grown, cannabis will primarily be used as input for the production of value-add products, as Canada continues to move towards the legalisation of edibles and extracts later this year.


Recently Canopy Growth entered the US market by establishing a Hemp operation that will be used not only for the production of hep for CBD-derived products but will also impact its outdoor cannabis strategy, as it seeks to optimise the methods used to cultivate current and future crops at the outdoor site

"Our team has outdoor, at-scale cannabis expertise gained from over a decade of hemp farming experience, including Canopy's 4,000-acre hemp operation executed last year, the extract of which is bolstering our CBD supply for the medical and recreational markets," said Canopy Growth President and co-CEO, Mark Zekulin.

Once the entire outdoor cannabis cultivation, production, and extraction system is fully licensed it will serve as a major contributor to the production of CBD to support value-add products like beverages, chocolates, and vape devices at higher margins than are achievable using inputs from indoor and greenhouse facilities, and other third-party off-take agreements.


"With more product formats coming to the Canadian market later in the year, we are working hard to ensure that we are ready to hit the ground running with products, formats, and brands that Canadians trust."

– Bruce Linton, Chairman, and Co-CEO of Canopy Growth


The developments outlined below will support revenue generation from the second phase of Canadian recreational products, expected to be in the market late Q3 fiscal 2020.

Highlights include:

  • Tens of thousands of square feet at their Smith Falls facility will be devoted to the production of chocolates. Once federal regulations over cannabis-infused concentrates, edibles and beverages are implemented, Canopy Growth estimates a monthly production capability of more than 850,000 chocolates with the option to scale up.
  • Approximately 125,000 sq. ft. of bottling space at its new beverage production facility which will once licensed and operational, have the capacity to produce more than 5 million beverages per month (expected by Q2 2020.)
  • IP-protected processes and equipment in place to produce more than 800,000 pre-rolled joints monthly.
  • Production capacity of over 15 million softgels per month, with scaling underway to increase this output.
  • Patented extraction and vape production capabilities with capacity to produce more than 2 million vapes monthly.

What is clear is that although there are still massive losses, the company is scaling up to maintain its position as the dominant supplier to the Canadian recreational market.


The Bottom Line

Constellation Brand's CAD$5 billion investment into Canopy late last year, combined with their current production capacity, international coverage, and just recently passed acquisition agreement with Acreage codlings make them a solid bet to continue their dominance of the global cannabis industry for some time to come.

The cannabis industry is booming, and if the recent report from BDS Analytics come to fruition, then Canopy's total addressable market may continue to grow at over 25% per annum for the next decade. This is a global green rush and Canopy is moving quickly and effectively, to position itself for growth in every corner of the planet.


They have a solid management team, significant brand awareness and a cultivation footprint unlike no other.


They have the strongest foothold in the Canadian recreational industry and are primed to take advantage of Legalisation 2.0 when Canada legalised edibles and extracts later this year.

They are still burning significant amounts of cash, and at some point, investors are going to want to see a plan and road profitability, but for the moment, growth and reach seem to be more important than profitability. After all, Amazon followed this exact same strategy (growth over profitability) and it seems to have worked out pretty well for them.

We're still extremely bullish on Canopy and see them maintaining their market leading status for many years to come.

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Mark Bernberg
Mark Bernberg

Mark Bernberg is a long-time cannabis investing enthusiast and founder of The Green Fund, Asia Pacific's preeminent media house, positioned at the forefront of the global cannabis industry.

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