Value proposition

Canopy Growth Plunges 12% After Earnings: The Sneaky Value Proposition (NASDAQ: CGC)

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Canopy growth (NASDAQ: CGC) plunged after declaring his income, and no doubt rightly so. The company continues to guzzle cash and margins have been shockingly negative even after a host of adjustments. There’s a real case of value to be made here after accounting for the company’s equity investments, but the ongoing cash burn raises the risk profile significantly. With the stock now at multi-year lows, potential investors could get an attractive price for taking on that level of risk.

CGC share price

CGC finds itself trading at multi-year lows – essentially giving up all of its gains after Canada legalized recreational cannabis.

Data by Y-Charts

It’s a stunning back and forth performance, which seems to imply that CGC would have been better off not being in the Canadian cannabis business in the first place. When looking at the financial metrics, it’s hard to argue against such a statement.

Profit from CGC shares

CGC saw its net revenue decline by 25%, with negative adjusted EBITDA still exceeding the total net revenue of $122 million.

financial summary

Presentation Q4 2022

These figures are generous, even. As seen below, CGC’s non-cannabis businesses, such as BioSteel, saw only a 3% decline in revenue. The cannabis side of the business all saw revenue drop by more than 30%.

Income distribution

Presentation Q4 2022

Negative gross margins of 142% were a disappointing result.

gross margins

Presentation Q4 2022

This number included write-downs related to the closure of various facilities. Recall that CGC, like many well-known Canadian cannabis companies, had overinvested in large cannabis facilities shortly after Canada legalized cannabis, largely on the premise that they would be able to produce cannabis. and export it to the United States. This thesis did not materialize, resulting in many additional costs that cannot be supported by sales in Canada alone.

adjusted gross margin reconciliation

Fourth Quarter Fiscal 2022 Filing

The adjusted gross margin of minus 32% was still very low. Management estimated that after further adjustments, gross cash margin was approximately 7% in Canada. On the conference call, management reiterated its belief that it can achieve 35% gross margins over time through both planned cost improvements and a greater push towards premium brands.

Given the low gross margins, it’s no surprise that the company also generated low adjusted EBITDA margins, which came in at -109% in the quarter.

Adjusted EBITDA

Presentation Q4 2022

The company hasn’t seen significant improvements in its margins in recent years, making it a legitimate concern for execution issues. CGC has now guided to achieve Adjusted EBITDA profitability by FY24 in its Canadian cannabis business (next quarter would be Q1 FY23). The company had previously guided to achieve positive Adjusted EBITDA in the second half of the past fiscal year. I had previously expressed great skepticism about management’s ability to achieve this goal. At this point, investors might be asked to be very skeptical of these projections.

Cash was $1.4 billion versus $1.5 billion in long-term debt. The company had net cash of $4 billion in 2018, but has since spent much of its cash. True, the company has $900 million in investments, mostly made up of investments in US companies such as multistate operator TerrAscend (OTCQX: TRSSF) and edibles companies Wana Brands. But the company is unlikely to monetize these investments given that they are crucial to the investment thesis. All of this means the company could run out of cash in no time – the company spent more than $500 million in cash last year and will therefore likely have net debt in the coming quarters. When you combine negative cash burn with net leverage, it can quickly become a financial solvency risk.

Is CGC stock a buy, sell or hold?

Even so, one could make a case of reasonable value here. At recent prices, the stock is trading at less than 5 times annualized sales. If one thinks they can achieve gross margins of 40% and adjusted EBITDA margins of 20% over the long term, then the valuation may make sense. I previously calculated a potential valuation of $1.1 billion for TRSSF’s stake upon legalization. If we also take Wana Brands’ $451 million valuation at face value, then there is approximately $1.6 billion in net worth. For reference, the current market capitalization stands at just under $2 billion. After subtracting investments (repeat I gave a generous valuation for TRSSF’s stake), the company’s operations are valued at around 1x sales. That’s a legitimately cheap multiple, especially if CGC can hit its margin targets.

At the same time, investors would be right to fear that continued dilution will reduce the value proposition over time. There is also no guarantee that management will be able to improve its business operations – I personally find it worrying that other Canadian operators will be able to generate strong margins while CGC is losing money. .

I still rate the stock as buyable due to the projected high return on success, while cautioning that the probability of success is not so high. I continue to prefer the allocation to names in the US cannabis sector, as the expected return potential is comparable or even higher, and many of them are already generating strong EBITDA margins.