Well that was disappointing. On Wednesday, the cannabis industry leader – Canopy Growth Corp (TSX:WEED) – posted results that shocked the markets. Not in a good way.
The company posted a hefty net loss of $3.70 per share, far more than the $0.41 loss that the market was expecting. Likewise, first quarter revenue of $90.5 million missed by 19% or $21.27 million. Ouch.
Despite a 249% jump in revenue year over year, there are already signs of slowing growth. First quarter revenue dropped by $3.6 million quarter over quarter. Is this a sign that demand is already starting to flatten?
Pot stocks were trading at valuations reflective of triple-digit growth rates. Many investors who were new and just learning how to buy stocks in Canada were attracted to cannabis stocks.
It is therefore not surprising to see its stock price plummet over the past couple of days, as new investors are much more prone to selling off when prices get rocky. Since releasing earnings, Canopy Growth has lost approximately 20% of its value. These were clearly some of the most overhyped Canadian stocks to buy in a very long time.
Declining revenue isn’t the only concern. Margins are still contracting as the industry is seeing costs rise and selling prices fall. Analysts expect this trend to continue as the company is still aggressively building out operations. Likewise, value-add products are more cost intensive and require considerable up front capital expenditures.
Cannabis assets are costing these companies a premium
Most Pot companies have paid quite a premium to acquire assets and Canopy is no exception. Although it had the largest harvest in the industry last quarter, it came at a premium.
Bulls will point to the next big product cycle such as oils and edibles as another source of significant growth. However, if we have learned anything from the past year, the potential is most likely over-hyped.
Cannabis oil and softgel products aren’t flying off the shelves as initially expected. In fact, the company has taken a $6.4 million hit to revenue as it expects these products to be returned unsold.
Following results, management has admitted that it is three-to-five years away from profitability. The industry remains plagued by operational inefficiencies, including a shortage of retail stores. The rollout in Ontario has been nothing short of a disaster.
At this point, investors who are sitting on significant losses are hoping that the legalization of edibles will be the spark that once again lights a fire under the sector. After all, there has been plenty of manipulation, scaring investors out of the sector.
Sales of cannabis-infused edible products is expected to reach $4.1 billion by 2022. In contrast, Canopy is worth $13 billion on its own. It is therefore unlikely that edibles alone will be the catalyst the industry needs to justify high-growth valuations.
Although I have no doubt that edibles will be a tailwind for the sector leading into legalization this coming October, don’t expect it to be as pronounced as last year. Fool me once, shame on you; fool me twice, shame on me.