David George-Cosh

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Shares of Canopy Growth Corp. rallied on Wednesday after the company reported slightly better-than-expected third-quarter revenue and an improved outlook in its U.S. operations helped to buck a decline in its cannabis sales.

As cheaper pot prices in the Canadian market led the Smiths Falls, Ont.-based company's cannabis business to post an eight per cent sales decline to $83 million, Canopy is redoubling efforts to improve quality for its dried flower products while also keeping an eye on its U.S. strategy, according to Chief Executive Officer David Klein.

"We want to make sure that we have unparalleled routes to market so that we can build the Constellation Brands of cannabis," Klein said in an interview, referring to the U.S. alcohol distributor that also owns a 38 per cent stake in Canopy.

Canopy's road to the U.S. remains a hot-button topic for investors and market observers alike. The company paid handsomely for the options to buy multi-state operator Acreage Holdings and cannabis edibles maker Wana Brands once the U.S. legalizes pot, while also expanding its Biosteel sports drink, CBD vape, and Martha Stewart edibles product lines.

It's the latter that ultimately shows up Canopy's balance sheet - Klein noted that Wana and Acreage remain off the books despite their strong financial performance - and is included in its consumer product business which rose 19 per cent to $58 million in the quarter.

That helped to offset that broader decline in its Canadian business while steering its revenue down by eight per cent to $141 million in its fiscal third-quarter while posting an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) loss of $67.4 million. Analysts polled by Bloomberg expected Canopy to post $137 million in revenue while booking a $65 million adjusted EBITDA loss.

Also weighing on Canopy's results was a stark decrease in the company's gross margins, which fell to seven per cent from 16 per cent a year earlier as a result of price compression in the Canadian cannabis market and higher supply chain costs.

Those lower prices come amid an ongoing influx of new and existing competitors in the Canadian market, which has seen Canopy's share of sales in the country drop several ranks to fourth place, according to Hifyre data. Klein hopes that can be turned around as it looks to improve the quality of its dried flower products across its three remaining production facilities with an emphasis on more premium offerings that command higher margins.

"A lot of our market share gains last year were admittedly on the back of value [brands]," said Klein in an interview. "We're really just focused on premium and mainstream [brands] understanding that's going to cost us market share in aggregate."

The company isn't providing any further clarity on when it expects to be profitable, with Klein saying an update will come when Canopy reports its fourth-quarter results in May. The company did post a $115 million net loss in the quarter, while its cash reserves further declined by $900 million to $1.4 billion. The cash burn was attributed to the company's EBITDA losses, capital investments, and the upfront option payment to acquire Wana Brands. Canopy also wrote off $36.4 million in asset impairment and restructuring costs in the quarter.

However, analysts appear to be still waiting for more positive signs of Canopy's turnaround as they note Canopy's ongoing cash burn remains an issue. Cantor Fitzgerald Analyst Pablo Zuanic also noted that Canopy is now in a net debt position with nearly $1.5 billion in long-term debt outstanding.

Stifel Analyst Andrew Carter maintained a "sell" recommendation on Canopy's stock noting that the company used up $168 million in cash while only spending $1 million on capital expenditures.

"While the headline may drive the stock higher, the fundamental performance suggests a continued fundamental deterioration with no consistent evidence validating the company’s strategy or execution," Carter said in a note to clients.