Breakeven?

Canopy Growth posts record revenue and a smaller loss as it eyes profitability.

OTTAWA • It’s been a very good stretch for Canopy Growth, the country’s cannabis pioneer. Shares in the Smiths Falls, Ont., firm jumped 4.5 per cent Monday to $ 31.95 after posting record second-quarter revenues and narrowing its losses. The previous Tuesday, voters in three U. S. states approved measures to fully legalize marijuana, thus joining the 12 states that already permit such sales. Dozens of other states permit some form of marijuana use, including for medical use.

If there was a down side, it’s the continuing uncertainty about whether the U. S. federal government will finally remove cannabis from its list of controlled substances. A change in legislation will likely require approval of the Senate — and it won’t be clear until early January just which party will wind up with control. If Republicans win one of the two upcoming contests for Senate seats in Georgia, federal legalization is considered less likely, though it’s possible the president could amend the legislation with an executive order.

This matters to Canopy Growth because it has already paid a small fortune to put into place a contingency for taking advantage of a possible new marijuana law. It has aligned itself with Acreage Holdings, a New York- based cannabis firm with operations in multiple states. In the event of federal legalization in the U. S., Canopy Growth would have the right to acquire Acreage and begin an aggressive assault on the U.S. market.

Meantime, David Klein, Canopy Growth’s CEO since January, has been busy restructuring a firm that expanded massively in anticipation of revenues that did not arrive.

The revenue shortfall was huge. Consider that little more than a year ago the consensus revenue forecast for Canopy Growth for fiscal 2021 (ending next March 31) was a shade more than $ 1 billion, according to analysts surveyed by Thomson Reuters.

Just prior to Monday’s report, the revenue consensus had been scaled back to $504 million.

That will be bumped up a little after the company reported second- quarter net revenues of $ 135.3 million, 16 per cent better than forecast. That represents a gain of 24 per cent year over year, excluding a hefty charge in the second quarter of 2020 related to product returns.

Even so, the overall shortfall in revenues is a problem because Canopy Growth, along with so many of its competitors, raced to build out capacity following Canada’s legalization of recreational marijuana two years ago, and are thus faced with significant fixed costs.

During the two years ended March 31, 2020, Canopy Growth bumped its head count from 1,035 to 4,434, including nearly 3,400 in Canada. That hiring binge, along with investments in manufacturing, bottling facilities and corporate acquisitions, helped to produce cumulative net losses of $ 2.1 billion during fiscal 2019 and fiscal 2020.

Since his arrival in January, Klein has shut facilities in B. C. and overseas, and trimmed Canopy Growth’s staff 16 per cent to 3,700 ( of whom 2,900 are in Canada and 1,245 in Smiths Falls, Ont.). More cuts may be in store.

The company ’s second- quarter operating loss was a more manageable $284 million.

“We haven’t been running efficiently because we grew ( our operations) so quickly,” Klein told analysts Monday. It didn’t help, he added, that Canopy Growth chased after everything in the early months of legalization — dozens of variants of gels, drinks, edibles and other cannabis products. “The company bit off too many complexities,” Klein added, “and aggressively introduced too many products without understanding the customers.”

This is the language of experience, of an executive with deep knowledge of what it takes to create and maintain a brand, and establish who is buying it. Klein and his new team have been spending much of this year collecting data and analyzing market niches to determine where they should be investing their efforts to greatest effect. It sounds simple but it’s not.

And it’s made more complicated by the fact Canopy Growth’s primary market is oversupplied with competitors. As of late May, Health Canada had granted nearly 400 licences to cultivate, process or sell cannabis.

Canopy Growth’s saving grace is that it was early to seek out a large corporate ally. And it landed a big one.

Late in 2018 the company received a $5.1 billion equity investment from Constellation Brands, the wine, beer and spirits giant. The New York- based conglomerate had been looking to diversify into higher growth products.

Canopy Growth’s cash reserves have slipped to $ 2.0 billion, but the biggest chunk of the decline took place in fiscal 2020. The drop between March 31 and Sept. 30 has been a relatively modest $264 million.

Mike Lee, the firm’s chief financial officer, said Canopy Growth is putting into place measures that will result in annual savings of $ 150 million to $ 200 million. Some of this will involve reducing the number of products and making better use of the firm’s manufacturing networks — some plants will specialize in high- volume production while others will concentrate on higher- quality products. Lee reckons he can save “tens of millions of dollars” with a more efficient procurement system.

If Lee manages to shrink these costs as planned over the next two years, the company would make considerable strides toward breakeven. Unless, of course, the U. S. Senate makes cannabis legal — in which case Canopy Growth will begin to invest more heavily south of the border.