Cannabis plants are seen from an overhead viewing window at Canopy Growth's Tweed visitor centre in Smiths Falls, Ont., on Sept. 18 2018.Fred Lum/the Globe and Mail
U.S. wine and beer giant Constellation Brands Inc., which drew global attention with its US$4-billion investment in Canada’s largest pot producer last year, has cut its fiscal 2019 profit outlook partly as a result of costs tied to the deal.
Constellation, whose stock price sank 12.5 per cent to US$150.94 on Wednesday, lowered its forecast amid weak wine and spirits sales and a roughly 25-cents-a-share pretax hit from higher interest expenses tied to its investment in Canadian cannabis producer Canopy Growth Corp.
Still, Bill Newlands, incoming chief executive and current president of Constellation, told analysts the company remains bullish on the cannabis segment.
“We believe the emerging cannabis space represents one of the most significant global growth opportunities of the next decade, and, frankly, our lifetime,” he said.
Constellation, known for its Corona beer and Robert Mondavi wine, was among the first alcoholic beverage companies to enter the fast-growing cannabis market with its investment in Canopy, starting in the fall of 2017 and boosted a year later. It prompted other consumer product makers to race to find their own marijuana deals.
However, pot stocks have taken a dive since recreational cannabis became legal in Canada in mid-October as pot retailers struggle with a shortage of product and underwhelming sales.
In November, Canopy released worse-than-expected quarterly results, sending its shares down 9 per cent on the day and reducing Constellation’s fair value in the pot producer by US$164-million.
Nevertheless, Canopy’s shares jumped more than 13 per cent on Wednesday after brokerage firm Piper Jaffray started covering the cannabis sector with a bullish report. Piper Jaffray analyst Michael Lavery predicted the global cannabis market eventually could be worth up to US$500-billion. “While timing of further changes is difficult to predict, the pace of further legalization appears to be accelerating,” he wrote.
Because recreational cannabis is illegal federally in the United States, banks have resisted investing in the sector even though 10 U.S. states and Canada have legalized the product.
Still, Constellation’s Mr. Newlands said recent U.S. legislative reforms have legalized the production of industrial hemp, including cannabidiol or CBD, a non-psychoactive cannabis compound that is believed to have significant medical benefits. Companies such as Constellation and Canopy are betting heavily on producing beverages and foods infused with CBD; Canada is expected to start permitting the sale of some cannabis-infused foods and non-alcoholic drinks by this fall.
Even so, analyst Bonnie Herzog at Wells Fargo Securities said “the U.S. government may embrace an unfavourable regulatory framework,” suggesting it may not make it easy to operate in the cannabis sector. At the same time, she recommended long-term investors take advantage of the pullback in Constellation’s stock, partly because the Canopy investment is still “an opportunity.”
Mr. Newlands said Canopy is using proceeds from the Constellation investment to bolster its global leadership in the cannabis industry with strategic partnerships and acquisitions. As a result, he’s confident Canopy will reach its goal of $1-billion of revenues within 18 months, he said.
David Klein, chief financial officer of Constellation, said it will only exercise its warrants – or options – to buy more Canopy shares in November, 2021, “if it makes sense and the business is unfolding as we expect."
“So if that business is going well, we think our investors will be happy for us to exercise those warrants,” Mr. Klein said. “And if the business isn’t going well, we’ll have a lot more cash to return to our investors.”
Lauren Lieberman, an analyst at Barclays Bank, pointed to market concern about the degree to which Constellation’s profit may be hurt next year and beyond from the Canopy investment.
Mr. Klein countered that Constellation expects Canopy to generate “very attractive” operating margins, similar to those of consumer packaged goods companies. As well, “there’ll be drags on their business from investment in R&D [research and development] and the cost of opening additional markets," he said. Constellation expects the Canopy transaction will add to earnings by fiscal 2021.
Constellation provided no financial outlook for Canopy’s business because it will report its year-end results in mid-February, after which Constellation will provide guidance, Mr. Klein said. It expects “out-sized returns on our total investment in Canopy.”