Motley Fool - Wed Nov 23, 7:35AM CST
Cannabis producer Canopy Growth (NASDAQ: CGC) has been focused on the U.S. market for multiple years now. In 2019, it announced plans to acquire Acreage Holdings, and since then, it has made similar deals with other companies.
But promises of long-term growth are nothing new for the cannabis industry. Investors interested in the industry need to be careful about getting caught up in the hype. And when it comes to Canopy Growth, there are some serious red flags investors should consider before taking a chance on the stock.
Canopy Growth has been expending resources on expansion into the U.S., but there's one huge problem: They can't operate in the market just yet. And while the launch of Canopy USA (where it will consolidate its U.S. investments) may have you convinced it's inevitable, in reality, it could still take many years for regulation to take place (assuming it does at all). Canopy Growth's aggressive plans to consolidate results from Canopy USA could also risk the company getting delisted from the Nasdaq.
Setting up Canopy USA is just one example of how the company spent resources where it may not have made plenty of sense to do so. Although it's not explicitly stated how much, the company is incurring costs on something that may not be all that beneficial for the business right now. Its wretched bottom line -- which was at a net loss of 231.9 million Canadian dollars in the second quarter (period ended Sept. 30) -- or nonexistent sales growth are areas that should be higher priorities right now.
The company's net revenue for Q2 was CA$117.9 million and declined 10% year over year. But some of the worst numbers came from the Canadian market, where Canopy Growth's recreational sales crashed 35% to CA$38.1 million. Its business-to-business sales declined by 40%, while revenue from the business-to-consumer market fell by 23%.
Investors may be surprised to learn that two years ago, Canopy Growth's revenue from the Canadian recreational market totaled CA$60.9 million; it has declined by an incredible 37% over that time. Although Canopy Growth is looking to focus more on the U.S. market, by not growing and achieving strong results in Canada, it isn't putting itself in a good position for success if and when the opportunity to enter the U.S. market arises.
To make matters worse, Canopy Growth is also burning through increasingly more cash. The cannabis company reported a free cash outflow of CA$135.4 million during Q2, which was 34% more than the amount it used in the prior-year period. The company does have more than CA$1.1 billion in cash and short-term investments that can help absorb the cash burn, but it's not sustainable in the long run.
Investors may be tempted to invest in Canopy Growth in the hopes that it will be a big winner when the U.S. legalizes marijuana, but that's by no means a sure thing. For the company to be in a good position to enter the U.S. and grow its business, it needs strong financials -- something it doesn't have today.
And investors also need to prepare for the worst-case scenario: that legalization doesn't take place for years. Its core Canadian operations don't look great, and with deep losses, plenty of cash burn, and sales dropping significantly, the business simply doesn't make for a good investment today.