Canopy Growth is Gearing Up for Much Higher Expected Demand

Canopy Growth Corporation (TSE:WEED) saw decreased profitability in Fiscal 2017 as they prepared for cannabis sector growth

Thomas Chapman | June 29, 2017 | SmallCapPower: In Fiscal Year 2017, Canopy Growth Corporation (TSX: WEED) saw decreased profitability as they prepared for growth. Highlighted by a series of acquisitions, and production capacity expansion, Canopy Growth gears up for the legalization of recreational cannabis in Canada, as well as an anticipated increase in medical marijuana demand. The Company’s stock fell 5.6% on Tuesday due to Canopy Growth falling short of consensus revenue and EPS estimates.

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Canopy Growth grew revenues 207% to $40mm in FY 2017, compared to $13mm in 2016. The increased revenue was largely due to incremental revenue streams as the Company began to sell cannabis oil through its Tweed and Bedrocan brands, as well as increased volumes of dried cannabis at slightly higher prices, reflecting a larger patient base. Revenue for Q4/2017, however, was $14.7mm, representing a 192% increase from Q4/2016, yet falling short of analyst consensus estimates of $16.4mm. This highlights the dangers associated with high multiple growth companies. If their often-astronomical growth projections do not meet investors’ expectations, the stock price will fall.

Canopy Growth Patient Base

Source: Company Filings

When assessing the Company’s profitability, it is important to remove non-cash gains included in its cost of sales. Canopy Growth works through these calculations and comes up with a metric called “adjusted product contribution.” For FY 2017, the Company’s adjusted product contribution was 63% of revenue. The table below illustrates the ability of Canopy Growth to sell cannabis products at a high margin.

Adjusted Product Contribution

Source: Company Filings

Adjusted EBITDA, a profitability metric that adjusts for non-cash expenses, was -$5.3mm for the year, showing a bigger loss than -$4.4mm in 2016. The Company’s decreased profitability can be partially attributable to costs associated with growth initiatives. Including: $7.3mm in acquisition related costs, and an additional $1.7mm to SG&A thanks to the Mettrum acquisition. This illustrates how the Company’s growth initiatives have resulted in declined profitability.

In terms of gearing up for growth, Canopy Growth made significant moves this year, including:

  • The acquisition of Mettrum on January 31, 2017, for $430mm in stock, which added two new products to Canopy’s portfolio, 40 acres of land with over 500,000 sq. ft. of available space, including 168,000 sq. ft. of production space, and increased the Company’s customer base to over ~39,730 patients.
  • The licensing of new grow rooms at its Smith Falls campus that increased flowering space by 50% and has received approval for several additional rooms that will triple the Company’s order fulfillment capacity.
  • The acquisition of rTrees on May 1, 2017, which added 90,000 sq. ft. of production capacity sitting on 11 acres of land with the capacity to expand to 300,000 sq. ft. Production is expected to begin in July 2017

Canopy Growth states they may continue to expand capacity through the acquisition of select ACMPR licensed producers. Furthermore, to help expedite the expansion process the Company entered a Memorandum of Understanding (MoU) with the Goldman Group in 2016, in which the Goldman Group will purchase to build new properties subject to Canopy’s approval and growth specifications. This gives the Company access to non-dilutive capital, which will accelerate the development and additional licenses production facilities. Canopy Growth put the MoU to work, and on June 23, 2017, they announced they will expand its footprint into Edmonton, Alberta with a 160,000-sq. ft. production facility that will be leased to Canopy Growth by the Goldman Group. The Company’s grow capacity is currently 39,000 Kg, which is by far the largest out of any LP in Canada.

Canopy Growth is trading at an EV/Forward Sales multiple of 10.8x, which is lower than selected peer median of 24.5x. This likely reflects its peers’ aggressive growth plans in terms of expanding their current growth capacity. In terms of EV/Expected Planned production capacity ($ per gram), Canopy Growth is trading at $31.7, which is far greater than selected peer median of $10.83.

Canopy Growth Comp Table

Source: Ubika Research

Canopy Growth is a company that has been preparing for growth in the Canadian cannabis market. With a growth capacity of 39,000 kg, a customer base of 55,601 patients, and gross margins of 63%, they are well positioned to take advantage of growth in both the Canadian recreational and medical marijuana space. They must, however, grow revenue 185% in 2018 to meet target expectations. If they can’t do this the stock price should fall, making for a risky bet.

Disclosure: Neither any of the principals at Small Cap Power, nor their family members, own shares in any of the companies mentioned above.

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