Canopy Growth Stock: Bankruptcy risks are growing like a weed (NASDAQ:CGC)
The last time we covered Canopy Growth Corporation (NASDAQ: CGC), we didn’t expect it to be in its current form two years from now. It may have been a bold statement, but we felt it was warranted given the facts of the situation. The stock nodded to our bearish view and has fallen around 50% since then.
Bulls might see this as an opportunity. We see this point as just another entry from which, again, you could lose 100% of your money. We explain why below.
A hangover is no fun
A very bad group of investors has been created in the period 2020-2021. They clung to revenue growth, “gross profits excluding everything” and all the other metrics that only made sense if you were investing in kindergarten. But, and here’s the but, it worked for a while. The incredible fiscal and monetary dual stimuli unleashed at the same time made everyone believe that the madness was sustainable. CGC was one of the main beneficiaries. While its main boom predated COVID-19, it hit a pretty remarkable 50X sales in 2021.
Although this multiple has decreased, it is far from sufficient and here is why.
End of growth
CGC took away the last pillar of hope for investors in the last quarter (10-K). Revenue was down 5% year over year.
That might have come as a shock to the growth crowd, but those were just the annual numbers. The numbers for the last quarter were absolutely horrendous. Revenues of $111.8 million were 25% lower than last year. This equates to a run rate of approximately $450 million. As a reminder, investors should keep in mind that CGC predicted a $1 billion in sales run rates all the way back in 2019.
What about profits?
Reverse earnings engineering is usually very difficult in companies where the idea was to grow to profitability. So when sales drop and the company has been investing to grow for years, total chaos ensues. CGC was no different and adjusted gross margins seemed like something out of a nightmare.
An adjusted gross margin of minus 32% is so bad that we doubt anyone would fund that, even as a startup today.
Free movement of capital
The only bright spot in the report was that the cash burn was only $121.8 million. We are not facetious here. Based on the front row numbers alone, we would have expected this number to be ahead of last year. But CGC was able to control capital spending and squeeze a tight quarter for cash burn.
Let’s look at this timeline
In the past fiscal year, CGC spent nearly $1 billion in cash.
Cash and short-term investments were $1.4 billion as of March 31, 2022, a decrease of $0.9 billion from $2.3 billion as of March 31, 2021, reflecting losses of EBITDA, capital investments and the initial payment made in consideration of the option to acquire Wana Brands on the federal authorization of THC in the United States
Source: Canopy press release
Over the past three years, CGC has incurred losses of approximately $3.4 billion. It reported asset write-downs and restructuring costs in each of the past three years.
It was only by reducing its investments (see the last highlighted line above) that it was able to maintain modest cash consumption.
The first hurdle for CGC here is the July 2023 notes. As can be seen below, CGC has adjusted net debt based on the market price of these notes.
They are currently trading even lower than that, at 88 cents on the dollar. Thus, your yield to maturity on these one-year (approximately) notes is approximately 19%. This shows how big the market thinks the risks are here. We have five quarters from the numbers reported above until these notes are due and even a modest consumption rate of $100 million per quarter ($500 million total) and repayment of the $600 million dollars will leave almost all of his money wiped out. Let’s not forget that his credit facility is based on LIBOR plus 8.5% and all those rate hikes Powell throws into the ring to fight inflation will have big consequences. The risk is even greater, as a slightly more aggressive depletion rate will prevent repayment of the loan. Remember that the credit facility requires a minimum of $200 million in liquidity at all times. It is therefore not possible to repay the loan in cash and there is only one realistic choice.
CGC will have to start monetizing its investments. In this market, we would expect a best case of a 50% discount to what they paid and at least 30% below what they mark as of March 31, 2022.
Even a hard sell and debt repayment would buy CGC about two years of cash burn at current rates. The stock remains incredibly expensive at 3.6 times sales. We say this because our best case is an extremely low margin business that can generate tiny profits. If only we had someone like that making very small profits per dollar of sale. Oh wait, we do. Cardinal Health Inc. (CAH) is an extremely profitable business, but earns very small profits (3.63% gross margins) per dollar of sales.
It’s a dividend aristocrat and valued at 0.088X sales. If CGC miraculously turned its gross margins negative to 3.63% and somehow erased most of its debt, a 0.1X sales multiple would be fine with them. That brings us to about 10 cents per share.