Pablo Zuanic from Cantor Fitzgerald kept a rating of “Neutral” for the stocks of Canopy Growth Corp. WEED CGC and lowered his 12-month price target to C$6.75 from C$7.75 due to the sectoral derating and reduced estimates.

The Thesis

According to Zuanic, Canopy’s cost savings measures and efforts to pivot away from value in the domestic recreational business should help the firm reach its target of positive EBITDA in the fiscal year 2024. However, he noted that “more clarity on the pace of cash burn” would help the cannabis company.

“There was little improvement in FY22 vs. FY21, and at the current pace net debt could be a steep 1.6x sales by March 2023 (true, Constellation Brands [STZ/NC] exercising more warrants would help the balance sheet, dilution notwithstanding),” Zuanic wrote in a Friday analyst note. “Efforts to continue to build the US THC ecosystem make sense given private sector valuations, even though they will not contribute to the P&L for now.”

In the first quarter of 2022, Canopy’s recreational sales fell 22% (vs -2% for the market), cannabis adjusted gross margins were -72%, and adjusted EBITDA was -$122 million.

“We stay Neutral and wonder if the focus on building US assets has put the company at a disadvantage in Europe, should markets there legalize before the US,” Zuanic added.

Sales for 4Q 2022 

• Total sales of $112 million were below FactSet’s consensus of $130 million.
• Recreational B2B sales ($26 million) continued to drop (-22% sequentially vs. -2% for the market), as the company tries to step back from the deep discount segment and focus more on the mainstream and premium segment.
• B2C sales ($13 million) fell 10% sequentially.
• Domestic medical sales were stable at $13 million.
• Exports were stable in the $9 million range (including $4 million to Israel), while US CBD dropped to $2 million (from $4 million).
• The C3 unit in Europe was sold midway through the quarter so only $3.1 million in revenues were booked.
• Non-cannabis sales fell sequentially ($46 million vs $58 million) mostly on seasonality and the pipeline fill from BioSteel in the December quarter.

Profitability and cash flow

• Reported gross margins were negative $159 million (due to charges) on $112 million in revenues, while adjusted gross margin was -32% (-$36 million).
• Adjusted gross margins for cannabis were -72% (partly due to inventory obsolescence) and 25% for the non-cannabis unit (vs. 37% in the previous quarter).
• Adjusted EBITDA was reported as -$122 million (-109% of sales vs. FactSet consensus of -52%). Free cash flow was -$127 million with minimal CAPEX ($64K) in the fourth quarter of 2022; for the fiscal year, 2022, FCF was -$582 million.

Balance sheet

Canopy ended March with a net financial debt of $129 million (cash ($1.37 billion and debt of $1.5 billion), or about 0.3x annualized sales.

“While the debt is manageable, we wonder about the pace of cash burn given the lack of meaningful improvement,” Zuanic wrote. “At this rate, by end of FY23 net debt could be >$700 million (or 1.6x sales). Asset impairments and restructuring costs in the fourth quarter of 2022 amounted to $241 million and other restructuring costs recorded in COGS were $119 million (the combined guidance for both items as per the 4/26 press release was $350-550 million).”

Outlook

“The company now expects to be EBITDA positive in FY24 (ex-investments in the US THC and BioSteel), with trends improving throughout FY23 – prior to this announcement, there was no target date to reach positive EBITDA. Cost savings announced on 4/26 to be achieved in 12-18 months ($30-50 million in COGS and $70-100 million in SGA) should help these efforts,” Zuanic wrote.

“While we do not expect all gross savings (33% of sales taking the high end) to flow to the EBITDA line, these targets, plus efforts to improve the price mix of the domestic recreational portfolio should allow for improved EBITDA trends, in our view,” he said.

“As per our math, Canopy Growth’s rec share was 5.6% in the fourth quarter of 2022 (taking reported B2B sales and grossing up to retail prices) compared with 9.7% in the June qtr of CY21 and 11.9% for all FY21 (ending March 2021).” 

Valuation and price target

Regarding Canopy’s price target, Zuanic said, “We note on average US MSOs trade at 2.5x CY22 sales. For price target purposes we take 7x core cannabis sales, which results in a 12-month price target of C$6.75 (vs. C$7.75 before due to reduced estimates and sectoral derating). In our view, future actions that Constellation Brands may take could weigh on the stock; we continue to think it would make more sense for STZ to acquire all the Canopy Growth float rather than wait to strike the warrants when they are in the money.”

Image By Ilona Szentivanyi.