Despite a sharp decline in shares of Canopy Growth (CGC) after disappointing earnings results on Wednesday evening, many analysts following the stock believe the long-term outlook should provide confidence in a dip buying opportunity on CGC.
Shares of the Canadian cannabis leader are slated to close the week on a sour note, having fallen nearly 8% near midday as larger-than-expected losses, integration risks of major acquisitions, decelerating recreational use in Canada, and shrinking margins move the market to a cautious stance.
"There's just so many questions," Action Alerts PLUS portfolio manager Jim Cramer said. "That's why the stock is down."
However, as CEO Bruce Linton anticipates margins have reached their trough and the long-term outlook for cannabis remains in view, many on Wall Street consider this is just a growing pain of an emerging industry rather than a sign of a struggling company.
"We continue to estimate a $250-500 billion potential long-term global cannabis market, with a $15-50 billion near-term opportunity, and believe Canopy is well positioned in the sector," Piper Jaffray analyst Michael Lavery said. "We consider Canopy's topline revenue growth on track, and we expect growth to accelerate as industry-wide supply shortages subside and hemp-derived CBD products are commercialized in the US."
He noted that medical sales will likely carry growth in the future as supply lanes and distribution are ironed out as well, helping blunt the potential for recreational buyer fatigue. Further, he expects the large-scale investments and acquisitions the company is pursuing at present will provide significant growth in the long term.
"We recognize that there are some growing pains as Canada launches an entirely new industry segment, but we believe F4Q19 revenue growth was appropriate considering Canopy's F4Q19 capacity improvements are more likely to bear fruit in F1Q20," Lavery concluded.
Additionally, investors should not lose sight of the fact that Constellation Brands' (STZ) backing of the company for over $4 billion provides a significant lifeline amid near-term losses.
For example, it would likely be unthinkable for Canopy to acquire U.S. cannabis company Acreage Holdings (ACRGF) were it not for the major cash infusion it received in late 2018 from Constellation. While the $300 million buyout of the company will be a material impact in the coming quarter, Linton noted it expands the horizon for distribution and offers an important footprint in the U.S. market as bipartisan support for marijuana legalization builds.
Linton noted that the scale is important to both Canopy and Constellation, even if it tempers the results in the immediate term.
"If you look at Q3 fiscal 2018 Canopy had about 600,000 square feet of license facility and we understood this and delivered the margin, gross margin greater than 50% and we could have stayed there and we would have been a nice tidy little company probably quite profitable," Linton explained on Friday morning. "But what we thought was important is when you acquire a bigger supporting partner and they bring C$5 billion and there's a global opportunity, which we are in our opinion in the best position for, is use that capital to build scale and we did."
Linton acknowledged that this growth stage has hampered margins, but stated his belief that the reported 16% margin figure represents the trough as higher-margin products such as candies, beverages, and vapes come into play more broadly and high charges on scale-building initiatives subside.
As such, the pain is sustainable and does not dampen much of the bullish sentiment emanating from major firms.
"As the company continues to ramp up its infrastructure, operating losses fell a bit shy of our expectations, further deepening from FQ3 levels," Canaccord Genuity analyst Matt Bottomley wrote to clients on Friday. "But given that the industry is still in a rather steep ramp-up phase and with C$4.5B of cash on its balance sheet, we are not overly concerned with profitability for the quarter."
Jim Cramer, who has touted the company as his top pick in the space, urged investors to eye the long term for such a nascent industry.
"They're spending like mad because they want to be the only guy," he explained. "They want to make a moat, they want to make it so no one else goes into the business because they are going to lose too much money."
"I think it's an effective strategy, just not for shareholders right now," Cramer added. "I still like it because [CGC] ultimately will be the winner."