CGC
Cannabis

Canopy Growth Corp’s (NYSE:CGC) Three Pillars Supporting Their Growth Prospects

The boom in the price of Canopy Growth Corp (NYSE:CGC) over the past year has been explosive. The period witnessed an over 112% increase in the stock price, far overshadowing the market (the S&P 500 index) which grew by only 0.5% over the same period. Over the start of the period, a number of factors were considered when assuring investors that the stock would actually rise as it has. These factors acted as driving forces to the valuation attached to the stock and they have continuously been adjusted since then.

The most recent announcement by the firm regarding its last quarter performance has garnered mixed reactions from investors and analysts. While the stock price has continued to rise since the announcement, some analysts have opted to take a step back and re-evaluate whether the firm is actually meeting all the parameters which were used in the valuation process. Following this, some of these firms have come back with different valuation reports for CGC, some which have been a downgrade from previously high prices (as is discussed later in this piece).

Nevertheless, the price of the company has been on a rising path. While, like other stocks, it was affected by exogenous factors during the final half of 2018, the stock has continued to show its resilience since then, rising by nearly 100% from $25 back towards the end of December to its current price of $46.27 as seen in the chart below:

CGC Daily Chart

Following the announcement of the company’s performance, the co-Chief Executive, Bruce Linton made some announcements regarding the future of the company and what they would be looking at. In this piece, we review this announcement against the critique made by analysts regarding the stock so as to establish which side the stock will linger towards both in the short and long-term.

Brief History

Canopy Growth Corp has become synonymous with marijuana across the globe. The company is a 2013-formed entity (which was known as Tweed Marijuana Inc until 2015) is headquartered in Smiths Falls, Canada. Its growth across Canada has been driven both by an improved product line, continued investment into product development, diversification into different geographical regions globally as well as the synergies it has developed by merging forces with other key sector players such as Constellation Brands (NYSE:STZ).

The Future Is Bright

As previously stated, following the announcement by CGC on their financial performance, the co-Chief Executive spoke to MarketWatch about the future of the firm. In his view, there were three key factors which the firm was looking at streamlining: hiring the right people, smart capital expenditures as well as the proper allocation of the scarce cannabis resource. According to him, the synchronizing effect of the above three would be consequential to the future of CGC.

First was about hiring smart people.

The firm’s labor force has increased by 285% since last year, having hired over 2,000 employees to total 2,700 people till now. The directors believe that CGC can only perform as well and much as the hired personnel. Thus, the firm has continued to hire personnel based on the growing demand for its services across divisions and geographical regions.

This is not without costs as the payroll fees continue to rise. The most recent announcement saw the payroll hit US $36.4 million, having ballooned from US $1.1 million in a similar quarter last year. Furthermore, the total marketing expenditure has also risen to US $35.3 million, up from $7.4 million.

Second is on the smart capital expenditures.

Here, it was critical that Linton pointed out that these expenditures were more a matter of theories developed in house rather than certain working models. While CGC has put up about US $391 million in capital expenditures, up from US $68 million the previous year, it is still yet to clearly define how this form of expenditure will be done. Moreover, the cannabis industry is still quite young and thus has more unknowns than knowns. Resources, therefore, need to be set aside to ensure they can tap into new yet volatile markets such as South America. The hope is that they can eventually venture into these markets and subsequently grow therein, albeit the high risk associated with them.

Finally, there was cannabis resource allocation.

CGC has four uses of the cannabis it cultivates: research and development (R&D), sale to medical users, export to other countries and sale to recreational users. The stated order represents the priority given to each of the above from R&D which is given the highest priority. The firm has to continuously balance between the above four and ensure that they do not miss out on any of the categories (this would be detrimental to their revenue goals).

In their view, while the rest of the categories mean a lot to their top lines, CGC is making efforts to ensure that they do not lag behind in R&D. Should the quality of their output be the best in the industry, the rest will come seamlessly to them.

A Few Reservations

A thesis has been brought forth by GMP Securities’ Martin Landry which provided the reason behind the downgrade of CGC’s share price forecasts from US $52 to $49.

In the firm’s view, there are a number of concerns governing this downgrade. First, CGC’s stock of finished goods has declined from $56 million reported in the previous quarter to $22 million in the current quarter. According to GMP, this is expected to have significant ramifications on the firm’s short-term growth and this may allow its competitors to surpass them, should they build up strong inventory and have aggressive expansion plans.

Furthermore, the firm is yet to establish a specific path towards achieving profitability. Given the growing costs, which are currently ballooning past its revenues, GMP is yet to see the path expected by CGC to ensure that they turn EBITDA positive and consequently revenue positive. This ties to the revenues made by CGC which are growing at a much slower pace than expected. CGC made a mere $2.7 million in additional revenue over the past quarter which was much lower than GMP’s estimates.

With the above, especially the revenue aspect, GMP has opted to take a second look at the stock so as to establish whether it will actually succeed as has been sold to investors across the globe.

Conclusion

There are two presentations which have been made in this piece, all of which carry considerable weight. On one side, CGC alludes to both itself and the sector being very young, therefore a steep learning curve is adopted so as to achieve the future growth prospects. On the other, GMP Securities is pointing out that the firm needs to have learned enough by now to have created a pipeline and work plan towards achieving profitability.

In our view, CGC needs to implement some of the assertions made by GMP while continuing on its growth path. While the review by GMP is one taken by a more mature company, the effect of an EBITDA positive company far outweighs the cost of coming up with the aforementioned work plan. As a result, while GMP’s reservations are taken into account, the growth prospects of CGC remain strong.

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Disclosure: We have no position in CGC and have not been compensated for this article.

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Canopy Growth Corp’s (NYSE:CGC) Three Pillars Supporting Their Growth Prospects
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