Despite a marijuana boom amid the pandemic, some Canadian cannabis stocks have failed to generate profits. There are many reasons for this, including fewer legal stores than anticipated, a smaller market than that of the U.S., black-market sales eating into revenue, and regulatory holdups. All of these have dug into Canadian pot companies’ sales.
Popular Canadian players including Aurora Cannabis (NASDAQ:ACB) and Canopy Growth (NASDAQ:CGC) have been struggling for a while now to achieve positive earnings before interest, tax, depreciation, and amortization (EBITDA). I continue to doubt that Aurora will bounce back anytime soon, but Canopy might just be a little luckier. While the company isn’t profitable yet, it does have the financial backing of U.S. beverage giant Constellation Brands as a plus point. The latter invested 245 million Canadian dollars in its partnership with Canopy in 2017. Exercising its warrants since then has given Constellation a 38.6% stake in Canopy. But is this the only reason to trust this pot stock?
Canopy Growth’s revenue growth is not enough to bring in profits
Canopy is growing revenue, but that growth isn’t significant enough to generate profits. In its 2021 fiscal fourth quarter (ended March 31), revenue jumped 38% year over year to CA$148 million. For the full year, revenue came in at CA$547 million, up from CA$399 million in fiscal 2020. Canopy saw growth in almost all of its business segments for the full fiscal year 2021:
- Canadian recreational sales were up 32% year over year to CA$230 million.
- Medical cannabis and others (including CBD-related products — CBD, or cannabidiol, is a non-psychoactive component of marijuana) grew by 23% year over year to CA$149 million.
- Other consumer products (which includes business from vaporizer maker Storz & Bickel, skincare brand This Works, and others) jumped 62% to CA$168 million from the year-ago period.
Canopy did manage to reduce its EBITDA losses for the quarter. These came in at CA$233 million, compared with CA$991 million in Q4 2020. That’s thanks to the company’s business transformation plan, initiated in December 2020, which helped lower its selling, general, and administrative expenses to CA$148 million from CA$197 million in the year-ago quarter. In the earnings report, CFO Mike Lee said that the company expects to realize CA$150 million to CA$200 million of cost savings from this plan within the next 18 months.
Canopy Growth is excited about the U.S. market, but …
Canopy Growth’s CEO is pretty optimistic about the U.S. cannabis industry. And why not? Canopy has an edge over its peers in the U.S. market thanks to its strong partners, including Constellation Brands and U.S.-based hemp company Acreage Holdings. (Its deal with Acreage, made in April 2019, is contingent upon future federal marijuana legalization in the U.S.) However, the U.S. market is a long shot for now. To be profitable, Canopy has to grow its market in Canada and globally.
It’s making progress there, having managed to capture a 35% dollar share of the total cannabis beverage category in Canada in fiscal 2021. Beverages are a form of cannabis derivatives, the additional recreational products (vapes, edibles, concentrates, and more) that Canada legalized in 2019.
In the first quarter of fiscal 2022, Canopy has expanded its portfolio of tetrahydrocannabinol (THC, the psychoactive component in marijuana) beverages with Tweed Iced Tea beverages, and it launched Tweed Strawberry gummies in Ontario. We will know more about its product launch and growth strategies in its upcoming Q1 2022 results, due Aug. 6. In the meantime, management is excited about the acquisitions of Ontario-based cannabis brand Ace Valley and Toronto-based Supreme Cannabis Company (both completed this year), hoping these acquisitions will further add to its recreational cannabis revenue growth.
Is this pot stock a safe bet?
Management stated in the earnings report that Canopy is on track to achieve positive adjusted EBITDA by the second half of fiscal 2022.
Unlike its peer Aurora Cannabis, which has a reputation for setting aggressive targets and failing to achieve them, Canopy’s goal seems reasonable. Though Canopy cannot reap the benefits of the U.S. cannabis market now, if it manages to generate profits just from the Canadian and international markets, it will be more than ready to capture the U.S. cannabis market eventually with the help of its partners. Its cannabis-infused beverages and chocolates are gaining traction in the Canadian market, and could be a huge hit in the U.S.
However, investors should also take note of how the company is handling its debt issues. Even though Constellation is doing most of its heavy financial lifting, Canopy’s balance sheet is messy. It ended fiscal 2021 with CA$2.3 billion in cash, cash equivalents, and investments, and long-term debt of CA$1.6 billion. Unless it starts generating profits, the debt issues could become a big concern.
When it comes to valuation, we look at Canopy’s price-to-sales (P/S) ratio since the company is not yet profitable. Canopy is trading at 17 times sales. That’s expensive compared with its U.S. counterparts, which have higher revenue growth than Canopy but are trading at lower P/S ratios (between 3 and 9). Most of them, like Trulieve Cannabis and Curaleaf Holdings, are also profitable.
Canadian marijuana stocks are a risky bet right now (except perhaps for Tilray (NASDAQ:TLRY), which just turned in a profit in its recent Q4 ended May 31). Chances are, however, that Canopy could turn itself around. If you have a strong risk appetite and can wait to see Canopy achieve its full potential five to 10 years down the line, then it is not too late to buy this pot stock.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.