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Mark Zekulin captured the gist of the problem facing the country’s cannabis industry with a single comment during Thursday morning’s conference call with financial analysts.
“The Canadian market is six to 12 months behind where we thought it would be,” said Canopy Growth’s chief executive. “Sales of recreational cannabis are not living up to expectations,” he noted.
That much was obvious in the company’s second quarter results ended Sept. 30 — three months in which Canopy Growth recorded unexpectedly weak revenues of $76.6 million, down from $90.5 million in the first quarter ended June 30.
The reasons for the decline were many, and produced a number of knock-on effects, including a net second-quarter loss of $374.6 million compared with $330.6 million in the same quarter a year earlier.
News of Canopy Growth’s ugly quarter triggered a 17-per-cent decline the company’s share price, which hovered just a shade above $20 on the TSX in early morning trading. This compared with the peak of nearly $71 per share, reached during the euphoria surrounding the legalization of recreational marijuana on Oct. 17, 2018.
The problem, Zekulin suggested, was the extreme shortage of cannabis retail outlets in Ontario — which has allowed the illegal market to continue flourishing.
He’s not far off. Roughly two-dozen cannabis stores currently operate in the country’s largest province, where the vast majority of cannabis sales are done online through the Ontario Cannabis Store. This, in a province that could easily support 1,000 retail outlets.
Compare this with Alberta, for instance, where 300-plus retail stores operate, up from just 65 seven months ago.
As anyone who operates one of these outlets will tell you, buyers of recreational cannabis vastly prefer the experience of shopping in person, when they can consult staff on the myriad concoctions the industry now makes available.
Canopy Growth understands this as well as anyone because it runs 27 stores across the country under the retail banners of Tweed and Tokyo Smoke — in Atlantic Canada, Manitoba and Saskatchewan. It has also received licences to operate another seven stores in Newfoundland & Labrador and up to 38 additional outlets in the Prairies, including 18 development permits for stores in Alberta.
Then there’s Ontario, where Canopy Growth has partnered with three other retailers.
Zekulin’s view is that had Ontario rolled out bricks & mortar outlets in line with other provinces (except Quebec, where cannabis is sold through the government-owned SQDC) Canopy Growth would today be hitting most of its revenue and earnings targets.
Certainly the hiccups in the second quarter revealed a substantial bottleneck in the wholesale end of the industry — in other words, the part that sees Canopy Growth and other suppliers ship cannabis products to Ontario Cannabis Store or SQDC. In contrast, the segment involving sales of cannabis directly to retail stores seems to be doing rather well.
Canopy Growth reported gross revenues of $118.3 million in the second quarter, which included shipments to wholesalers and retail stores alike. But then two things happened. First, the provincially owned stores returned unsold products. Second, Canopy Growth conducted a review of its own cannabis inventories and concluded prices on many products had to be reduced while others had to be declared obsolete.
Net result: Canopy Growth backed out nearly $33 million worth of revenues from its second-quarter tally. Combined with some other items, this is what produced net revenues of just $76.6 million — down from $90.5 million in the first quarter.
However, the other aspects of the business showed impressive growth. Sales of medical cannabis in the international markets reached $18.1 million — up 72 per cent from the first quarter — while medical cannabis revenues from Canadian customers were up eight per cent over the same period to $14.1 million.
And even within the recreational marijuana segment, sales to retail stores were up 23 per cent to $13.1 million.
The big question now is whether Canopy Growth has made the appropriate adjustments to serve whatever lies ahead. It has spent a fortune to quickly build a global enterprise that at the end of September employed 4,550 — up from just 2,000 a year earlier.
While the Canadian build-out is nearly done, the company is still investing in U.S. operations and elsewhere overseas.
The Smiths Falls-based firm could and can afford to do all this thanks to a $5-billion equity investment by Constellation Brands, the U.S. wine-beer-and-spirits conglomerate. But Canopy Growth’s cash mountain had shrunk to $2.7 billion by Sept. 30. That’s still sizable, but Constellation Brands was nervous enough about the spending trajectory to insist on replacing former Canopy Growth CEO and founder Bruce Linton, who left the firm in July.
Interim CEO Zekulin in the meantime has taken on the job of steering the firm toward profitability “in the next three to five years.”
He said Thursday he expects the company will unveil a new boss in coming weeks.
“We built an incredible team here,” he said Thursday, “and an incredible company.”
The next few quarters will be critical for Canopy Growth. Its R&D, staffing and inventory levels are predicated to an uncomfortable degree on the actions of Ontario, which the company assumes will open up 40 new retail outlets per month starting early next year.
If Alberta, a much smaller province, can do this, surely Ontario can as well. But if Ontario continues to go slow, it will weigh on the results of the entire cannabis sector, not just its leading player.
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