Here’s Why the Best Is Yet to Come for Canopy Growth

The marijuana industry in Canada boomed amid the pandemic after cannabis was deemed an “essential item.” However, sales weren’t enough to compensate for the other headwinds the Canadian cannabis market faces. Among other things, a slow rollout of legal stores, regulatory hold-ups, and black-market challenges have challenged Canadian pot companies in growing their revenues enough to generate profits. Despite the hurdles, though, some are on their way to success — and one among them is Canada-based Canopy Growth (NASDAQ:CGC)

While Canopy isn’t profitable yet, it’s long been an investor favorite. The company was smart in its initial days of development, when the marijuana industry was in a nascent stage. In October 2017 — even before seeing state legalization ramp up in the U.S. or federal legalization move into the realm of the possible — Canopy partnered up with U.S. beverage giant Constellation Brands (NYSE:STZ) in a deal that saw the latter invest 245 million Canadian dollars into Canopy.

I must say it was a very smart decision. Here’s why Canopy Growth has a beautiful future waiting. 

A person holding a small cannabis plant.

Image source: Getty Images.

Performance hasn’t hit the mark yet, but …

Slowly and steadily, Canopy is growing its revenue. In its Q3, which ended Dec. 31, revenue was up 23% from the year-ago period to CA$153 million.

Canopy hasn’t been able to achieve positive earnings before interest, tax, depreciation, and amortization (EBITDA) yet, but is working on reducing its EBITDA losses. (Positive EBITDA is a sign of how well a company tackles its operating expenses. Meanwhile, net profits are the company’s earnings after it has made all deductions.) In its Q3, the company managed to lower its total SG&A (or selling, general, and administrative) expenses to CA$144 million, which helped EBITDA losses come in lower at CA$68 million, compared with CA$97 million in Q3 2020.

Cannabis derivatives could be a game-changer

Canopy is doing well growing its revenue steadily, controlling its expenses, and lowering its EBITDA losses. However, it is important that it achieves profitability or it will lag compared to its U.S. counterparts, most of which are already profitable. This is where high-demand cannabis derivatives come into the picture. Canada legalized derivatives — vapes, edibles, chocolates, beverages, concentrates, and more — in October 2019 as part of “Cannabis 2.0.” Derivatives offer consumers a different way to consume cannabis beyond the traditional way of smoking the flower.

Canopy has been very creative with its derivatives products, launching a wide array of options amid the pandemic. Its cannabis beverages in particular are a hit in Canada, according to the management, capturing a 34% market share for the quarter.

Canopy can achieve a similar presence in the U.S. if and when it launches these products. And many believe drinkable cannabis could take over the alcohol industry soon — the global marijuana beverage market could grow at a compound annual growth rate (CAGR) of 18% to reach $2.8 billion by 2025, according to Grand View Research. Holding a dominant position in this segment with its innovative products will give Canopy an edge over its peers.

The deep pockets it boasts because of Constellation’s investment will also allow the company to spend more on new cannabis products later in the year. Compare this with its peer Aurora Cannabis, which is struggling to survive and nowhere near launching any new derivatives.

Canopy Growth has some strong partners

To launch its new products in the U.S., Canopy can rely on Constellation’s extensive network throughout the country to help it establish a solid footing. Meanwhile, in exercising its warrants over time, Constellation has come to hold a 38.6% stake in Canopy. 

In April 2019, Canopy made an agreement to acquire U.S.-based hemp company Acreage Holdings, but that deal will only close if and when the U.S. federally legalizes marijuana. For now, the company is slowly moving forward with a different strategy in the U.S. As there are no restrictions on the use of the non-psychoactive compound cannabidiol (CBD) in the U.S., Canopy — along with Acreage — made an entry into the U.S. CBD beverage market in March with the launch of Quatreau, a premium ready-to-drink CBD-infused sparkling water.

This is not a cannabis stock you should miss out on

With its Q3 earnings results, management also discussed some of the company’s medium-term financial targets:

  • Net revenue could grow at a CAGR of 40% to 50% between fiscal 2022 and 2024.
  • It expects to achieve positive adjusted EBITDA by the second half of fiscal 2022.

Marijuana investors may note the long list of U.S. cannabis companies that are in a much better financial position than Canopy. But I believe investors should have faith in Canopy’s potential and the path it is carving for itself, though it may be a long road. With Constellation financially backing it, Canopy will be able to sell its innovative and varied recreational products to a wide customer base in the U.S. once federal legalization of marijuana happens. 

We will know more of this cannabis company’s plans for this year and beyond once it reports its fiscal 2021 fourth-quarter numbers on June 1. Interested investors will want to keep an eye on the results.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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