Canopy Growth Corp. shares popped more than 7 per cent on Monday, after the cannabis grower reported an increase in revenue in the face of challenging retail conditions as well as a smaller-than-expected net loss after a wave of layoffs and facility closings.
With legal cannabis dispensaries closed or curtailed because of COVID-19, Canopy’s recreational sales dropped 11 per cent in the three months ended June 30. This was offset by solid medical marijuana sales and better-than-expected revenue from its non-cannabis subsidiaries, which include a skin cream company and a vaporizer manufacturer. Net revenue was $110-million, up 22 per cent year-over-year.
Profitability remains a distant goal for the Smith Falls, Ont.-based company, which continues to bleed money quarter after quarter. Canada’s largest cannabis company did, however, manage to narrow its net loss in the quarter to $128-million, a 34-per-cent improvement year-over-year. The result beat analyst expectations and comes after months of aggressive cost-cutting by Canopy’s new management team, which was appointed by its largest investor, Constellation Brands.
Canopy is in a “transition year,” chief executive David Klein told analysts during a Monday conference call. After years of breakneck expansion, the company spent the first half of 2020 shuttering cultivation facilities and trimming its work force by 18 per cent. This was done to try to bring marijuana production in line with lower-than-anticipated demand in Canada’s legal market and to reduce the company’s bulging inventory of unsold products.
The cost-cutting measures began showing up in the quarter, as selling, general and administrative expenses dropped 23 per cent compared with the same period last year and free cash flow improved by 51 per cent.
Despite the lower costs, Canopy continues to struggle with poor margins. Even after closing several growing operations, including massive greenhouses in British Columbia, Canopy’s facilities are operating well below capacity because of a combination of excess inventory and low overall demand in the legal market. Gross margins in the quarter were 7 per cent, making Canopy one of the least efficient companies in the Canadian cannabis industry.
“We’ve taken the steps of getting our supply chain in balance. We know that in the short run that might impair our gross margin performance as we experience lower utilization levels,” chief financial officer Mike Lee said on the conference call.
“We also know some of our competitors are taking a different path, which is still continuing to operate at high-utilization levels, but producing perhaps three or four times their sales each quarter in their harvest, which puts all of that on their balance sheet. That’s going to come back at some point in terms of surplus,” he said.
As part of its effort to align production with consumer demand, Canopy is reducing the number of products it is selling. It has also shifted more production toward its value segment: low-priced cannabis that is marketed to win over consumers from the illicit market.
The value segment is rapidly emerging as the most competitive product space in the Canadian dried flower market, and Mr. Klein told analysts that value products could soon make up 50 per cent of the legal recreational market.
“If the majority of the illicit market is kind of price sensitive and is already playing in value, we’re just saying we’re taking share of the value market that already exists,” he said.
“The real end game is to grow the legal market pie as big as we can, and then look to trade those consumers up [to higher-priced products],” he said.
Over all, Canopy’s executives struck a cautiously optimistic tone on Monday, pointing to growing cannabis beverage sales and a number of initiatives in the U.S. cannabidiol (CBD) market. The company recently launched a U.S. e-commerce website for CBD and is launching Martha Stewart-branded CBD products next month.
How Canopy performs in the Canadian recreational market in the coming quarters will depend to a considerable extent on the pace of retail store openings in key markets such as Ontario. That, in turn, depends on the course of COVID-19 physical-distancing measures.
“In the meantime this has been a pretty good defensive play. Consumers are still spending on cannabis, and with more stores coming we think that’s going to continue to open up the market,” Mr. Klein said.
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Mark Rendell