Canopy Growth Corp (WEED)

[awesomesound]

The key investor takeaway is that Canopy Growth continues to have major flaws in its growth story. The company is chasing too many vast markets and failing to capture any of these at attractive margins or cash flows.

The stock valuation has gotten far too rich here at $8.5 billion, while analyst revenue estimates for FY21 remain a paltry $583 million. Do not chase Canopy Growth on this recent rally to $25.


Summary

Canopy Growth announced its cannabis-infused beverages aren't ready for production at scale.

The Canadian cannabis sector is trying to sell edibles at a very high costs per mg of THC.

The company is chasing a small portion of the U.S CBD market.

The stock has no business being at a market cap of $8.5 billion with out-of-control expenses and flawed business plans.

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The market was shocked last week to find out that Canopy Growth (CGC) hasn't been able to scale up cannabis-infused beverage production. So far, the market has generally ignored this huge flaw in the business built from the deal with Constellation Brands (STZ). The hopes were for the new CEO to streamline operations and cut money-losing divisions, but the initial work is even worse, requiring the executive to fix failed launches. My negative investment thesis is further reinforced here.

Image Source: BC Cannabis Stores website
Commercial Flaws

On January 17, Canopy Growth announced that it hadn't been able to transition cannabis beverage production from lab scale to commercial scale. The company only had seven weeks after receiving the license from Health Canada to get the production line at its new facility up to speed.

One can understand problems, but one can't understand how Canopy Growth took a month after launch to tell the public the company wasn't ready to produce THC beverages at scale. New CEO David Klein just took over on January 14, and the cannabis leader isn't going to provide an update on the progress until the FQ3 earnings report on February 14, or two months after the official launch of Cannabis 2.0 products in Canada.

The company promoted the Cannabis 2.0 products as ready for prime time via multiple press releases and media tours during the November and December months. In fact, Canopy Growth detailed a robust lineup of beverage options, including multiple brands, flavors, and THC levels.

Now that some of the excitement is coming off the bloom, investors probably need to come to grips with its other Cannabis 2.0 products. The award-winning chocolate lineup appears too focused on premium chocolate infused with THC and/or CBD, while missing the consumers' desire for high TCH for the cost.

According to this research by analyst Jerome Hass of Lightwater Partners Ltd., the typical Cannabis 2.0 product has costs per mg of THC far in excess of the black market.

People are already talking about how expensive [the 2.0 products] are and that’s going to have to come down because people can do the math pretty quickly. When you buy a chocolate bar in five portions with 2 milligrams of THC in each portion, that won’t appeal to an experienced user.

Again, the Canadian government appears to have placed such strict restrictions on the market as to kill demand. The Tokyo Smoke chocolate bar from Canopy Growth costs a similar $7.99 per bar for 10 mg of THC.

Source: BC Cannabis Stores

Considering the company promoted using an old Hershey chocolate factory to produce these chocolate bars, one has to wonder why it didn't go with a Hershey quality chocolate where costs outside of the THC ingredients are below $1 per bar. Any decision to create a mass-market product should, first and foremost, have a focus on maximizing the THC content per dollar of cost.

... a grey market website, run by the Victoria Cannabis Buyers Club, sells an infused chocolate bar for $13, but contains 375mg of THC.

For the same 375mg dose of THC, a customer would have to buy $299.63 worth of Aurora chocolate bars - that’s 2,300 per cent more per milligram of THC.
https://i.imgur.com/4KZh0yb.jpg

Implications

Possibly worse, Canopy Growth spent December launching CBD in the U.S. The First & Free brand was launched on December 12, when the company should've been busy scaling its cannabis beverages in Canada.

The CBD product lineup is intriguing considering the focus is on soft gels, oils and creams. Charlotte's Web Holdings (OTCQX:CWBHF) has already publicly stated these CBD products only account for up to 15% of sales when its full suite of edibles is offered. The products might not be under FDA scrutiny, but they offer limited revenue boost for Canopy Growth.

The implications here of launching the CBD brand in the U.S. and having the beverages business failing in Canada add up to higher costs without the revenues. Canopy Growth even forecasts the impact of not having the beverages line up and running at scale during the March quarter as not materially impacting FY20 revenues.

This statement is perplexing considering the company spent millions on a state-of-the-art facility in Smiths Falls, Ontario. The facility has the ability to produce 5 million beverages per month within 125,000 sq. ft. of bottling space.

The whole Constellation Brands investment was based on the cannabis beverages business, yet all of the numbers continue to suggest the market isn't that material to Canada or Canopy Growth. Back in 2019, Deloitte surveyed 2,000 Canadians to derive an estimated $2.7 billion annual market value for the derivatives market as follows:

Edibles - $1.6 billion
Cannabis-infused beverages - $529 million
Topicals - $174 million
Concentrates - $140 million
Tinctures - $116 million
Capsules - $114 million

Of course, the original opportunity was to perfect these items in Canada and eventually ship them globally. The global story has failed to materialize to the extent expected by the large Canadian players.

The ultimate implication is a lack of improving financials. Canopy Growth is still chasing every market and failing at some of them. In FQ2, the company had the following operating expenses amounting to adjusted expenses of C$160 million when excluding SBC and depreciation and amortizatio

Canopy Growth has to cap expenses at these quarterly levels, while growing revenues and boosting margins. The cannabis giant has to boost quarterly revenues to C$400 million in order for 40% gross margins to reach EBITDA breakeven.

Nothing about the Cannabis 2.0 launch in Canada or CBD launch in the U.S. is supportive of higher revenues or lower costs.

https://seekingalpha.com/article/4319403-canopy-growth-major-2_0-flaws