Canopy Growth Corp.’s CEO Mark Zekulin is calling on the Ontario government to immediately commit to opening more retail stores across the province, as the industry reels from declining revenues, weak sales, falling prices and an inventory pile-up.
“The fact of the matter is there are not enough stores, and enough supply. The Ontario government has made it clear their desire to have more stores, but why wait three months? Fix it now,” he told the Financial Post in an interview.
Both Canopy and Aurora Cannabis Inc., two of the country’s largest licensed producers, saw major declines in revenue for the quarter ending Sept. 30.
Canopy took a $32.7 million hit from product returns and pricing changes linked primarily to the sales of its oil and soft-gel capsule products, resulting in the company’s net revenue plummeting 15 per cent to $76.6 million for the quarter ending Sept. 30.
Aurora’s total revenue declined 24 per cent from last quarter to $75.2 million, which it attributed to the “slow pace” of retail store licensing.
Canopy shares tumbled 15 per cent, as investors reacted strongly to the biggest revenue decline the company has seen since legalization.
The Smiths Falls, Ont.-based licensed producer has struggled to meet its earnings goals over the past few quarters, as industry-wide price declines chip away at revenues and a lack of accessibility to legal weed in the country’s largest market stifles demand.
It is increasingly unlikely that we will achieve our Q4 milestone of $250 million in revenue
Canopy CEO Mark Zekulin
“There is still a $6 billion market out there in Canada to be converted. That conversion takes a whole bunch of things, but if convenient access is not there, you can only do so much,” Zekulin said, reiterating comments he made on a conference call with analysts Thursday morning.
Canopy’s soft-gel capsule sales have been a bane for the company — cannabis retailers and provincial boards across the country have been struggling to sell the Tweed-branded products, resulting in a glut of unsold inventory that was ultimately returned to Canopy. The company took an $8-million return charge last quarter from unsold oils and gel caps.
On the conference call, Canopy’s chief financial officer Mike Lee told analysts that the soft gels “issue” was “fully behind” the company, and there remained less than $10 million left of unsold product in provincial warehouses as of the end of last quarter.
The $32.7 million figure included actual returns from provincial wholesalers which amounted to $20.5 million, with an additional $6.4 million to be returned in the coming weeks, according to Lee.
But Zekulin argues that it is the lack of stores, and not the quality of his company’s products that is eating into revenue. “There is still interest in soft gels and oils. Demand has not been what it could have been. If there are more stores, we will see whatever volume that is selling, multiply by the number of stores,” he said.
While Canopy’s international medical revenue increased by 72 per cent on a quarter-over-quarter basis, buoyed by its acquisition of the German CBD pharmaceutical company C3, its domestic revenue — both medical and recreational — declined by seven per cent.
Although the company reportedly increased its share of the market in Alberta, where there are over 300 private retail stores, its adult-use revenue across the country declined by almost 10 per cent from the previous quarter.
“As Cannabis 2.0 takes place, people will gravitate towards chocolates, beverages, gummies. Soft-gels are a type of edible, so we think we will actually see increased demand for these products as people get used to consuming that way,” Zekulin said.
While Aurora’s cash cost to produce per gram declined significantly to just $0.85, one of the lowest in the industry, its quarter-over-quarter cannabis revenue fell by an alarming 25 per cent. Although the company’s medical patient base expanded slightly, it was not enough to offset major declines in wholesale and consumer cannabis revenues.
And, earlier this week, Organigram Holdings Inc. pre-released its earnings for the period ending Aug. 31, which also showed a 34 per cent decline in revenue, attributed in part to a $3.7 million charge on product returns and lower pricing. Organigram too cited a lack of retail stores in Ontario as one of the factors contributing to weak results.
There are currently just 25 private cannabis stores in operation across the province, with an additional 50 slated to begin operating early next year. In its fall economic statement, the Ontario government stated a commitment to moving towards an “open allocation of cannabis retail store licenses where the number of stores is limited only by market demand.”
The province also confirmed that it would allow licensed producers to establish retail stores at their production sites, and introduce an online click-and-collect system for private retailers.
Zekulin remains unconvinced that these incremental measures will do enough to help even out supply-demand imbalances. “The devil comes down to the details, and at the end of the day there are still unknown details and no real commitments. I’m not sure that Canopy will be allowed more than one licence to operate a retail store.”
In supplemental information provided to investors as part of its earnings release, Canopy mapped out a detailed scenario where it would take Ontario opening 40 stores every month for the next six months starting January 2020 for the company’s current production and demand to equalize, with 4.5 months of inventory to spare.
In addition to its product return and pricing challenges, the company took a $15.9 million writedown on excess inventory, again related to forecasted sell-in rates of its oil and soft-gel products. Gross margins slid into negative territory due to a $40.4 million impact from write-downs and returns.
“We believe this represents a red flag for the company and the industry as a whole as inventory balances held with provincial distributors have grown to a level that will likely continue to stymie near-term wholesale purchases,” said Canaccord Genuity Corp. analyst Matt Bottomley in a note to clients.
Bank of Montreal analyst Tamy Chen pointed out that while some LPs were downsizing production capacity given inventory concerns, Canopy harvested another 40,000 kilograms this quarter. “We believe investors are concerned that more inventory rightsizing could occur,” she wrote in a note Thursday afternoon.
Analysts on the company’s Thursday morning conference call also took aim at the company’s spending habits.
Canopy posted an adjusted EBITDA loss of $155.7 million in the quarter as they ramped up spending on sales and marketing (up 23 per cent) and general and administrative expenses (up 41 per cent).
It was widely assumed that Canopy would rein in its operating expenses after the firing of former CEO Bruce Linton, whose strategy of rapidly scaling up at the expense of the company’s core business of growing pot domestically, sparked the ire of Canopy’s biggest investor, Constellation Brands.
“I think it is fair to say we have built this company for the long term. We are fortunate to have $2.5 billion in the bank. We are not taking drastic steps that will undermine our long-term future … because we can afford to do that,” said Zekulin.
Management also confirmed that Zekulin would step down as CEO by the end of 2019, and a new CEO would be appointed “in the coming weeks.”