Nov 14, 2019

Blame Doug Ford: Canopy CEO cites retail woes for Q2 bomb

Canopy reports steep Q2 losses amid nearly $50M in charges


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On a day when investors punished Canopy Growth for widely missing revenue and earnings expectations in its latest quarter by sending its stock to a two-year low, its chief executive had a message for the masses: Blame Doug Ford’s Ontario government.

Canopy's chief executive officer Mark Zekulin acknowledged it has been a “challenging couple of quarters” for the cannabis sector as a still-thriving illicit market and emerging oversupply conditions have led several pot companies to report disappointing results.

But perhaps no challenge has been greater than the slow rollout of cannabis retail stores in Canada’s biggest cannabis market, which Zekulin pointed to as a key factor that significantly weighed on the company’s revenue miss.

“To be fair, licensed producers like Canopy should take responsibility for the initial supply challenges that forced Ontario to strategically make other plans and result in a subpar retail framework,” Zekulin said.

“But the fact is: there are not enough stores [in Ontario], there is enough supply and the inability to get more stores rolled out is dramatically hurting the sector.”

Zekulin said he’s relayed his concerns to the Ontario government and while people like provincial Finance Minister Rod Phillips are “saying the right things” there has been little follow-through on those discussions.

“Why it’s not just happening right away, I do not know,” he said. 

Jenessa Crognali, a spokesperson at the Ontario Ministry of the attorney general, said in an emailed statement to BNN Bloomberg that now that the federal supply shortage has begun to show signs of improvement in the past few months, the government can now “return to our original plan to allocate retail store licences based on market demand.” Crognali didn’t provide further details on when the government would move to a merit-based system in issuing cannabis store licences.

Canopy executives on a conference call with analysts remained optimistic that will change. Canopy’s chief financial officer Mike Lee said the company assumes Ontario will begin issuing new licences, allowing for 40 stores a month to open beginning in January, while consumer demand should reach “equilibrium” sometime in the summer or fall.

“If Ontario doesn’t open stores for another year, we have a problem,” Zekulin said.

However, BMO Capital Markets analyst Tamy Chen said in a report on Thursday that even if Ontario opens more stores, it’s hard to see how the province could open enough shops over the next year to fully absorb the industry's increasing production output, which includes the outdoor harvest soon to come to the market.  

Canopy’s second-quarter loss came to $374.6 million in the quarter, attributed to a restructuring of its portfolio of cannabis softgels and oils after recording “returns, return provisions, and pricing allowances” during the period. The company’s net revenue in the quarter totalled $76.6 million, which took into account a restructuring charge of $32.7 million related to its softgel and oil products and was down from $90.5 million from the prior quarter.  It also wrote down $15.9 million in inventory it now deems as “excess or obsolete”.

The company reported an adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) loss of $155.7 million. Canadian cannabis sales fell seven per cent from the prior quarter to $76.6 million after the company recorded a drop in business-to-business sales in the period. Canopy sold a total of 10,913 kilograms of cannabis products in its second quarter, up three per cent from its prior quarter.

“It’s fair to say it’s been a challenging couple of quarters in the cannabis sector," Zekulin said during an earlier conference call with analysts. "The market opportunity [in Canada] is not living to expectations."                                                               

Canopy said it now has $2.74 billion of cash, cash equivalents, and marketable securities as of its second-quarter, a sizable war chest that remains ahead of its industry peers, but down 39 per cent from the same period a year earlier. The company said it used $404.7 million in cash in the quarter, primarily for its operations as well as the construction of its manufacturing and beverage production facilities.

Zekulin said Canopy doesn’t plan to spend much money on building out infrastructure in Canada or Europe and while its global M&A programs are “substantially completed”, it may spend to invest in the U.S. hemp sector where the company aims to become a major player in the CBD space.

Canopy’s rough quarter may see investors remain on the sidelines in the cannabis sector until companies report several consecutive periods of profitable results, said Gordon Reid, president and CEO of Toronto-based Goodreid Investment Counsel Corp.

“This is eight out of the last 11 quarters that Canopy has missed expectations, and they’re not alone,” Reid told BNN Bloomberg Thursday. “From an investing standpoint, this is a minefield. We’ve been asked, ever since legalization happened [in Oct. 2018], if we want to take a position and we’ve straight out said: ‘No, thank you.’ We’ll wait and see. I’d much rather be paid a much higher price for much greater certainty than get into what is a black hole at this point.”

Last month, Canopy began to unveil some of the next-generation cannabis products the company's management hopes will be part of its drive to profitability. The cannabis producer showcased its new chocolate products, several new drink offerings, including a "distilled" cannabis-infused beverage, while its new vape devices with "proprietary" technology will be launched later this month.

This is also likely the last quarter Zekulin be a part of Canopy’s management team. Zekulin, who assumed the top position after his co-CEO Bruce Linton was fired by Canopy's board in July, said a new chief executive will take over the company by the end of the year. ​

Zekulin said Canopy is in the final stages of its search for a new CEO and expects to make an announcement in the coming weeks.