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Canopy Growth Corp. Intensifies its Growth Spending, Putting a Strain on Cash Flow

Canopy Growth Corp (TSX:WEED) shares are trending higher. At the time of writing, they’re 192% higher than they were a year ago.

Is much of the good news priced in for the short to medium term or is there room to go higher?

Competitive environment

While Canopy Growth Corp. certainly has its advantages, the fact remains that cannabis is a commodity.

While the company does have a leading position as far as production capacity and supply agreements with various provinces going forward, the agreements are not exclusive, thereby giving the provinces the ability to purchase supply from other cannabis producers, of which there is no shortage.

Reasons to pause

Canopy’s third-quarter fiscal 2018 results for the three months ended December 31, 2017 revealed two key trends that give me pause, especially given the stock’s valuation.

First, its sales of $21.7 million were shy of expectations, which were calling for sales of $24.2 million. This likely reflects the fact that expectations are getting ahead of themselves and are too bullish. Although this represents a revenue growth rate of 123%, the stock is trading at an expensive price-to sales-ratio of 88 times, so it’s very sensitive to numbers coming in below expectations.

Secondly, EBITDA was $-7.1 million compared to $-1.4 million in the same quarter last year, which the company’s spending needs in order to fund growth acceleration. At the end of the day, as investors we should be just as concerned with EBITDA, earnings and cash flow numbers rather than sales numbers.

Although analysts continue to raise their target prices on the stock, it feels like a reactionary measure in order to keep pace with where the market has taken it, rather than a measure that’s based on fundamentals.

The company has $450 million in cash and cash equivalents on its balance sheet, and this does provide some funding to support further growth initiatives going forward.

But — and this is a big but — the latest quarter saw a cash burn of $136 million as growth efforts intensify.

Going forward, there is no reason to believe these growth efforts will become less intense; on the contrary, they will probably become even more intense.

This places the company in a position where, although money has been raised through the equity markets just this year, we can reasonably expect that more money may be needed in the near future.

The amount of investment that needs to go into this emerging industry is big; we can thus expect more heavy expenditures in the years ahead.

There are still plenty of uncertainties, with policy and regulation subject to change, so the risk here is still big.

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Fool contributor Karen Thomas has no position in any of the stocks mentioned.

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