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Canopy Growth Corp. releases Q3 Earnings: Don’t Be Fooled

Today, Canopy Growth Corp. (TSX:WEED) released third-quarter earnings, resulting in a decline in the stock price of approximately 6.5% by midday. Although the news releases have discussed the massive beat on revenues and solid earnings, the reality is, the company is no better off than it was one quarter ago.

As an emerging company in a very new industry, there are still major steps being undertaken to secure a quickly growing clientele. The problem this quarter (just as last quarter) is where the money is being spent and where the “earnings” are coming from.

The earnings per share (EPS) were reported as $0.02 or $0.03, depending on if we take the basic or diluted number, while the actual cash flow from operations (CFO) is another story altogether. Just as the company did in the previous quarter, the value of inventory conveniently became much more than was previously listed on the balance sheet.

Stripping out the increase in value of the inventory, a number close to $41 million, the CFO was actually negative. Doing the math, the company saw approximately $0.095 per share go out the door during the quarter. Arguably, the negative cash flow can be viewed as a positive development as the cost of customer acquisition is included in this number.

To be fair to the company, the client base expanded to 29,000 people — up from the 8,000 at this time one year ago. Revenues in turn also increased from $3,481 one year ago to $9,752 — good signs for the company.

The challenge faced by any company in development mode is the scaling of the business. In this case, the customer base in the third quarter of 2016 was 362% of the previous year’s number (an increase of 262%), while revenues were 280% of the previous year’s number (an increase of 180%).

Clearly, things are not scaling the way investors like to see. For every new client the company takes on, the incremental revenue gets smaller and smaller, meaning the customer-acquisition cost is becoming a bigger part of the pie. At this stage, the company should not be running into this problem. The company should be bringing in money hand over fist.

Looking at the balance sheet, the company continues to acquire a number of competitors and raise money through the issuance of common stock. Although liquidity nor solvency are issues at this time, the reality is, the company could soon run into problems. Further, the amount of goodwill (a non-cash asset) on the balance sheet will be at risk of a write-down if things are not executed absolutely perfectly.

Looking beyond the headlines is an invaluable exercise in the case of Canopy Growth Corp. At a current price of approximately $12 per share, this company may still yet be overvalued given the negative cash flow and minuscule earnings per share.

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Fool contributor Ryan Goldsman has no position in any stocks mentioned.

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