Canadian marijuana giant Canopy Growth (TSX:WEED)(NYSE:CGC) made the big announcement that it’s shutting down two very large greenhouses and laying off about 500 employees as it undergoes an organizational and strategic review that could positively impact the company’s stock price in the long term.
Newly installed CEO David Klein is a strong numbers man. It was only a matter of time until he started taking the cash gobbling behemoth toward a sustainable business profile where some hopes of positive operating earnings can be entertained.
The two British Columbia greenhouses being closed down will take away three million square feet of productive space. Plans to bring a third greenhouse in Ontario online are also being halted.
Gross margins could improve
Retrofitted greenhouses must be more expensive to run than purpose built facilities, and management explained that its latest actions are an effort to align supply and demand “while improving production efficiencies...”
The company reported weak adjusted gross margins in the low to mid 30% range for several quarters in the past. I suspect that its undesirably high production cost profile is the reason why management suspended reporting the cash cost per gram metric that other industry players still divulge to this day.
If the greenhouses were not cost efficient, then a strong numbers man would prefer crossing them out to improve the company’s gross margin profile rather than keeping them at the expense of adjusted EBITDA improvements.
The company will still run its outdoor grow facilities as these produce low cost cannabis extracts.
I believe that these moves, which come at a heavy cost to the laid off employees and a $700-800 million charge, were a necessary adjustment to the company’s production and operating cost profiles. This should align well with investors’ desire for near-term profitability and boost Canopy Growth stock price.
Under pressure to adjust…
Canadian marijuana market demand is lagging behind supply growth by wide margins. Industry players have to adjust their production footprints and align their operating expense profiles with market size, as it has become apparent that their overly ambitious capital expenditure plans overshot the growth trend.
Aurora Cannabis started on this transformative path earlier. Canopy has followed on this path as the market remains smaller while the provinces take their time to increase marijuana retail outlets.
As the company and industry players can’t influence government policy, the only viable strategy is to look inside for operational adjustments and offshore for revenue expansion.
This resulted in a hemp focus in the United States and some significant manoeuvres in Germany, which became a great performing segment over the past two quarters as revenue jumped from a $4-5 million quarterly run rate to over $18 million.
Although a dark cloud still hangs over U.S. hemp, the company is trying its best to execute for growth. But huge operating expenses are exerting pressure on management to adjust operating settings so as to report better-looking income statements.
…and under pressure to perform
Given the huge operating losses reported recently, something has got to give for the company to entertain some hopes of breaking even any time soon, and there’s pressure on the new CEO to perform.
Cannabis is still a nascent industry that has yet to find its feet, and it usually takes a couple of years for execution to show desired results. Incumbents, however, were quick to tap the public during their infancy for capital to fund overly ambitious growth plans.
Public investor funds aren’t that patient, however. They come with the pressure for quick results every quarter. Canopy has many institutional investors, the biggest being Constellation Brands from where Mr Klein came to steer a turnaround strategy. He’s got to impress or be pushed to do the same.
Whatever forces drive the new CEO, the resultant transformative efforts should make investors happy, allowing Canopy Growth’s stock price to recover this year.
Motley Fool Canada's market-beating team has just released a brand-new FREE report revealing 5 "dirt cheap" stocks that you can buy today for under $49 a share.
Our team thinks these 5 stocks are critically undervalued, but more importantly, could potentially make Canadian investors who act quickly a fortune.
Don't miss out! Simply click the link below to grab your free copy and discover all 5 of these stocks now.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Brian Paradza has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Constellation Brands.