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Canopy Growth Q3: The surge is on

Is Canopy Growth (TSX:WEED) (NYSE:CGC) a bellwether for cannabis stocks? Third quarter results reported well after the close on Thursday make it appear so. Net revenues increased 282 percent to C$83 million ($62.65 million) reflecting a 334 percent jump in kilos sold to 10,102.

Operating costs increased fourfold to CA$169.7 million ($128.10 million). So operationally, all the growth in revenues, the Canopy lost CA$157 million ($118.51 million). For the record, a favorable swing in non-operating items resulted in CA$0.22 ($0.17) of per share earnings per share (primary).

This is the first full quarter of operating under newly legalized Canadian cannabis laws. The global investment world is watching closely for results. Thus far Canopy is the largest to report with Tilray and Cronos due any day. The report issued by Canopy put smiles on the face of investors and lifted the entire sector.

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Notable numbers

After this week’s Q2 report from Aurora, where they got squeezed from lower average selling prices and rising production costs, the Canopy gross profit margins warrant a close examination.

At first glance, they don’t pretty bad falling to just 12.7 percent in the latest period from 76.4 percent a year earlier.

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The most obvious reason for the deterioration is that 86 percent of revenues came from the newly legalized market. The average selling price CA$6.98 ($5.27) per gram is well below the CA$8.30 ($6.27) average last year at this time. But there are less obvious reasons.

Some CA$60 million ($45.29 million) of recreational cannabis was sold wholesale (business to business) where pricing is lower than retail. Our best estimate is that these forces were responsible for about one-half the reduction in gross margins. True this is not great but nothing to get alarmed about.

According to Canopy, the balance of the deterioration related to operating cannabis cultivation facilities (Delta and Aldergrove) and by absorbing CA$2.1 million ($1.59 million) in medical excise taxes. All together these items along counted up to CA$33.5 million ($25.29 million). Without these charges, gross margins would have been closer to 40 percent.

Investors should accept these numbers and the normal consequences of rapid growth. Gross margins are very likely to improve as each of the cultivation facilities reach full utilization and cycle past initial pilot harvests.

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Marketing to retail

Thus far Canopy has put most of its focus on production with licensed sites totaling 4.3 million square feet. As for retail, there are just two cities, Manitoba and Newfoundland where the company's 10 Tweed retail stores are located. The brand name is memorable and resonates almost everywhere. Presumably, the $5 billion investment by Constellation Brands will aid expansion of the franchise.

During the quarter Canopy acquired HIKU, owner of the Tokyo Smoke retail chain. Between the two distinctly different customer psychographics, Canopy plans to open 40 new stores in the near future.

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During Q3 the company took a number of actions to advance its brand presence throughout Canada, beyond current online sales. This involves typical consumer products like oral cannabis sprays and reformulation of slow-moving items.

Big on hemp

During the quarter, Canopy moved to capitalize on the passage of the new farm bill in the U.S.

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On January 14, Canopy was granted a hemp processing and production license by The State of New York. The company has been in development with a broad range of CBD products across multiple channels. To support this project Canopy projects to invest between CA$100-$150 million ($75.49-$113.23 million) in the New York facility.

Doing the right stuff

Between Q3 results and the information that followed, it is hard to complain much about what is happening at one of the industry’s leading companies. Little wonder then the news is helping the entire cannabis group. At the time of this writing, CGC price was up over 4 percent on the day and all but four of the 35 cannabis companies I monitor were ahead as well.

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