Fall earnings season is almost here. And many investors’ eyes are on Canopy Growth Corp (TSX:WEED)(NYSE:CGC). The largest TSX-listed cannabis producer, it is also the most traded by volume, and naturally, the biggest recipient of media coverage. Canopy is not, however, the most profitable of its peers, which makes this stock a particularly interesting one to watch ahead of its November 14 earnings release.
As the world’s biggest cannabis producer by sales, Canopy is in many ways a bellwether for the cannabis industry as a whole. So when attempting to forecast what’s in store for this company in its next earnings statement, it helps to look at the big question facing the entire sector.
Supply chain issues
When cannabis legalization came into effect on October 17, supply chain issues abounded. In provinces that allowed brick and mortar sales from day 1, the main issue was shortages; stores sold out quickly, and many remained sold out as late as November 1. In provinces that opted to delay brick and mortar sales, such as Ontario, the problem was fulfillment: many customers that ordered online had to wait an excessively long time to receive their orders.
All of this does imply a strong demand for cannabis. I would be very surprised if Canopy’s revenue isn’t up in Q2. However, the fact that stores sold out also means that revenue won’t be as high as it would have been had supply been adequate.
It is widely thought that pot stocks’ valuations ahead of legalization “priced in” the anticipated sales boost. If investors were expecting something truly massive, then even fairly sizable revenue growth may disappoint. In this context, October’s supply shortages may prove to be bad news for Canopy.
On the topic of revenue growth, Canopy is still a strong performer. It grew its revenue by 63% year-over-year in the most recent quarter. That’s a high number, and it places high expectations on Q2 fiscal 2019. In order for legalization to have had a massive impact on sales, we’ll want to see earnings growth that’s significantly higher than 63%.
In ordinary circumstances, simply continuing to grow at that rate would be impressive. But in the era of legalization, where valuations are reaching insane levels and investors are expecting a blowout, any less than triple-digit growth will probably disappoint.
We now come to the persistent sore point for Canopy: earnings.
Unlike several of its competitors, Canopy has failed to achieve a positive net income in the past four years. This is in part because of the company’s big ambitions: it is spending copious amounts of money building infrastructure to become the biggest cannabis producer in 11 countries. While this may explain the company’s persistent profitability issues, after Q2, it may no longer excuse them.
Legalization was the event that was supposed to bring cannabis to the mainstream and unleash a torrent of new sales that would drive cannabis stocks to the stratosphere. If Canopy can’t turn a positive net or operating income after all that, then investors may lose interest. That doesn’t mean Canopy isn’t a good play in the long term, but it may call its short-term value into question.
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Fool contributor Andrew Button has no position in any of the stocks mentioned.