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3 Takeaways From Canopy Growth’s (TSX:WEED) Horrible Quarterly Earnings

Leading marijuana growth stock Canopy Growth (TSX:WEED)(NYSE:CGC) released its anticipated fiscal second quarter 2020 results early on Thursday. In the midst of the largely bad news report were some small grains of hope-inducing numbers.

Second-quarter gross revenue had grown 6% sequentially quarter over quarter to a respectable $118.3 million, but there were some necessary charges to the revenue line of $32.7 million and net revenue declined 15% sequentially to $76.6 million for the three months that ended on September 30 this year.

Although revenue generation disappointed, medical sales have risen to the show; the numbers could otherwise have been worse.

A strong showing in medical cannabis sales

The company reported a strong 72% sequential quarter-over-quarter growth in international medical cannabis to $18 million, which was largely driven by new acquisition of C3 Cannabinoid Compound Company contributing a full quarter to the company top line for the first time. There was also a welcome return to growth in German medical sales after some supply constraint resolutions there.

Canadian medical sales grew 8% sequentially, but this revenue line is yet to reach the levels seen before the launch of recreational cannabis sales.

Significant problems with derivative products

There are serious problems within the product portfolio, as cannabis oils and soft gel capsules demand has lagged management estimates. The company has provided for millions worth of returns from the distribution channels and price adjustments to help move the stocks, and these charges amounted $32 million in the revenue line.

This is a significant disappointment, as these product lines were supposed to the high margin stock keeping units that would drive corporate gross margins in the long term.

Canopy was not the only company that has faced this challenge: even Cronos Group’s cannabis oils and extracts sales halved in the most recently reported quarter.

The big challenge is what will drive margin expansions when dried marijuana sales are already facing downward pricing pressure? Production cost management alone won’t cut it, and the company doesn’t look like a potential low cost leader in the short term.

A further surge in operating expenses

Operating expenses increased 15% sequentially to over $269 million, led by general and administration expenses and share-based compensation expenses of $87.86 million and $83.77 million, both of which far way higher than recognised net revenue.

Subsequently, adjusted EBITDA losses increased 69% to $155.7 million, and this figure is more than twice the size of quarterly net revenue recognised, potentially implying that the company is nowhere near profitability in the near term.

Exponential revenue growth is required for the company just to break even, and investors will look to the upcoming edibles legalization for some growth potential, but I wouldn’t be surprised if at some point in the near future management announces some cost rationalization measures, as HEXO has just done recently.

Foolish bottom line

The numbers do look terrible for Canopy, just as they do for most industry firms that have reported earnings or provided some guidance so far in November, but this is an industry that’s still in its infancy.

The learning curve may be long, and some early targets will be missed, but this leading player still has a strategic partner in Constellation Brands to steer the reigns through the bad times. Its cash balance is still respectable enough to oil a growth machine.

That said, new store roll outs are required in Canada for recreational sales to gain momentum, and we could see improvements in the next year as adult use retail chains expand across the provinces.

I’m still eager to see how U.S. hemp strategy will fare, but the stock may remain heavily subdued in the near term, giving contrarian investors some good entry points for long-term positions as the troubled giant works on its growth engines.

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Fool contributor Brian Paradza has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands, HEXO., and HEXO.

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