Weak Oil Sales And High Inventory Will Continue To Weigh On Canopy Growth
Summary
- Canopy Growth isn't likely to repeat its last performance in the quarters ahead.
- High inventory levels will remain a major challenge for the company.
- Weakness in its release of new products has to be solved in order to take advantage of derivatives.
Even though Canopy Growth (NASDAQ:CGC) managed to put together a decent quarter as measured by recent cannabis standards, there are still some significant underlying issues that will likely put pressure on the company going forward.
In this article we'll look at its high inventory levels and historical inability to identify what the cannabis market wants and at what level, such as with CBD oils and capsules, along with it losing some German sales that will go to Aurora Cannabis (ACB) in the current quarter, and the possibility it may never reach the potential it saw when it acquired the rights to buy Acreage Holdings.
Inventory levels will remain high
MKM analyst Bill Kirk has taken a contrarian view of Canopy Growth, primarily citing the high inventory levels that aren't going to be drawn down anytime soon. He noted that since the latter part of 2017, Canopy produced 115,000 kilograms of pot beyond what it sold.
He stated that the overall legal cannabis market has a run rate demand of about 180,000 kilograms. Kirk stated that if Canopy were to stop production completely at this time, it would take approximately 30 months to sell through its inventory in Canada.
The company also said its inventory will continue to increase before it reaches peak levels.
Unfortunately for Canopy Growth, this isn't only the result of overly ambitious production capacity, but also a history of not accurately identifying what the market wants in certain product categories, such as oils.
Even though investors and analysts touted Canopy's higher priced products in the last reporting period as a significant tailwind, with the high level of inventory and its weakness in identifying what the market wants in some categories, the company appears to be headed for more problems in the quarters ahead.
The one unknown at this time is how aggressively retail stores in Ontario and Quebec will be opened. If that surprises to the upside, Canopy could mitigate at least part of its inventory problem over the next year or two.
Until then, I expect downward pressure on its pricing power and more write-downs because of the need to generate revenue from its vast amount of inventory it has on hand.
To manage costs it will probably have to shutter some facilities until supply aligns with demand.
Acreage Holdings
I appear to be one of the few people who have never been impressed when Canopy Growth acquired the rights to buy Acreage Holdings. The issue there has always been whether or not the U.S. government would legalize recreational pot at the federal level.
I've clearly stated since the beginning of that idea that it wasn't going to happen soon, if ever. I maintain that thesis. How that will probably play out is each state, to one degree or another, will legalize pot - recreationally or medically.
As for federal legalization in the U.S., I don't see that happening for many years, if ever. For that reason, unlocking the value of Acreage Holdings isn't possible at this time. If it takes too long, the length of the agreement will expire, and if there is still no inclination to legalize pot in the U.S., I don't think Canopy will extend the rights. That means a big future write-off if that's how it plays out.
Conclusion
Canopy Growth, for the most part, enjoys some positive outlook for investors because of the billions Constellation Brands (STZ) invested in it. That hasn't done much to improve the performance of the company, and now the best that can be said is it gives it some breathing room during this bubble bursting.
The problem is Canopy needs to show it knows how to leverage that capital for long-term growth rather than see it continue to shrink from poor investment decisions, dismal results from weak products, and providing the means to pay off bills while it tries to find a path to sustainable growth.
Add to that the fact it won't be getting some of the revenue it got from Germany because of the temporary situation where Aurora didn't get a license in a timely manner. That was a one-off event that won't be repeated. That's important because German cannabis has strong pricing power and wide margins.
As with its peers, Canopy will have to wait for more retail stores to open in Canada, some of its weaker competitors to fold, and for the black market to start to shrink.
When that happens, more new customers will come on board as new derivative products provide alternative means of consumption. The negative for Canopy there, again, is that it hasn't been very good at identifying and providing the products consumers are looking for.
With its decent balance sheet and recent and somewhat successful attempt to transition to higher-end products, the company is positioned to grow in the years ahead if it can deal with its inventory problems and figure out what the market wants in certain segments that have a lot of long-term growth potential. I'm very neutral in regard to the future prospects of Canopy Growth, but if it can solve its numerous problems mentioned in this article, it could surprise to the upside over the long haul.
This article was written by
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