Canopy Margins Shrink as Pot Producer Expands, Revenue Beats

(Bloomberg) -- Canopy Growth Corp. shares gained after the company reported stronger-than-expected revenue for the quarter ended Dec. 31, but weaker margins remain a concern as the company rapidly expands its growing capacity, analysts said.

The pot producer’s stock gained as much as 7.8 percent Friday, even as production fell and costs climbed 15 percent over the prior quarter to levels “meaningfully higher” than the company’s peers, according to Cowen & Co. analyst Vivien Azer. Canopy expects margins to rise above 50 percent in the coming quarters as new facilities come online.

Key Insights

  • Canopy reported net revenue of C$83 million, up 282 percent from a year earlier and ahead of the consensus estimate of C$78.7 million. This was a “relief given the meaningful miss last quarter,” when Canopy reported its first sequential revenue decline in at least three years, Azer said.
  • Adjusted loss before interest, taxes, depreciation and amortization was C$75.1 million, wider than the C$45 million loss analysts had expected
  • Adjusted gross margin fell to 22 percent from 55 percent a year earlier due to higher costs related to cultivation subsidiaries that aren’t fully commissioned, the development of edible and beverage products which can’t be sold until later this year and lower average prices for recreational pot versus medical pot. Average selling price per gram in the quarter was C$7.33, down from C$8.30 a year ago
  • Despite the lower-than-expected gross margin and wider-than-expected loss, Canopy appears to have outsold all its competitors. Eight Capital analyst Graeme Kreindler estimated that Canopy captured 40 percent of the Canadian rec market, while BMO analyst Tamy Chen estimated that it captured 30 percent of the market
  • Canopy harvested 7,556 kilograms of cannabis during the fiscal third quarter, down significantly from the approximately 15,000 kilograms harvested during the second quarter and also below the total volume sold of 10,102 kilograms
  • Chief Financial Officer Tim Saunders will retire in mid to late 2019, the company said. The search for his replacement is underway and candidates have been identified

Management Commentary

  • “The company believes gross margins will improve in the coming quarters when all of its cultivation facilities reach full utilization,” Saunders said on the analyst call. Together with new, higher-priced forms of cannabis like edibles and beverages, this should help drive margins “north of 50 percent in the coming quarters”
  • Canopy should have CBD products available for sale in U.S. markets where they’re permissible by the fourth quarter of 2019 or the first quarter of 2020, Chief Executive Officer Bruce Linton said. He expects to have hemp production facilities in multiple states and said those facilities will “lend themselves extremely well to cannabis if and when” it’s legalized at the federal level
  • Linton said a clinical trial into sleeplessness could be at the “claims” stage by the fourth quarter, meaning Canopy would be able to start marketing its cannabis as a therapy to treat insomnia. This creates “quite a bit more potential for margin,” he said
  • “I would be kind of upset if we can’t maintain or improve” Canopy’s share of the Canadian recreational market, Linton said. “We should dominate and I will be extraordinarily disappointed if we don’t do that through science and claims and products”
  • Investors shouldn’t expect a dividend from Canopy anytime soon, Linton told BNN Bloomberg television. “We’re not here to hand out dividends, we’re here to create a dominant platform for the next five years”

Read More: Canopy Growth Results Suggest ‘Growing Pains,’ Piper Says

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