The Canadian Cannabis Market Is Under Pressure
If there is one thing becoming clear about the Canadian cannabis industry is that it is still under pressure. If not from investors then the business at least. The problem? The industry is still suffering from massive oversupply issues tied to overly aggressive forecasts and growth, the slow rollout of retail infrastructure, and intense competition.
Last week, Aphria (NYSE:APHA) reported its 2nd quarter earnings shocking the market with a surprise loss. The results highlighted lingering issues with overproduction and capacity that may not come into balance for several more quarters. Today’s news includes a report from Canopy Growth Corporation (NYSE:CGC) that proves not all cannabis companies are in the same boat. Where Aphria is struggling to produce bottom-line improvement even after aggressively curbing growth plans and capital spending Canopy Growth Corporation is not.
At first glance, the report from Cronos Group (NASDAQ:CRON) echoes that of Aphria. The company produced impressive top-line results that, when filtered down to the bottom line, left a lot to be desired. Digging deeper into the report it becomes clear that 1) Cronos is not immune to problems plaguing the industry and 2) it may be time to start adding more Cronos to the cannabis portfolio.
Is Cronos Group Mixed Results An Opportunity To Buy?
Cronos Group reported a hefty 29.2% increase in YOY profit for the second quarter, beating consensus by 900 basis points. The strength is attributable to growth within the Candian adult-use market, the roll-out of Legalization 2.0 (vaporizer products and consumables), and the acquisition of Redwood. The Redwood acquisition is important to remember, it is Cronos Group’s entre’ to the U.S. market via hemp brand Lord Jones.
Revenue was impaired by the impact of non-recurring wholesale revenue. Wholesale revenue is derived primarily from Canadian provinces for the medical market and/or adult-use market, depending on how the province’s system is set up. Last year, wholesale revenue was enormous due to over-purchasing related to the aforementioned overly aggressive forecasts. The bad news is the impact on revenue in the “now” period, the good news is that this headwind to sales is largely if not completely behind us.
On the bottom line, results were not so rosy. Earnings per share came in at C-$0.31 per share, near a quarter short of the consensus, due to a convergence of factors. The increase in adult-use sales came at a cost, expenses related to those sales increased over the previous year affecting the total mix. That was compounded by the lack of wholesale revenue and a write-down to inventory.
The write-down to inventory is evidence of the oversupply/overcapacity issue within the industry. Declining prices for both dried flowers and extract cut into the bottom line to the tune of $3.1 million. The silver lining here is twofold. On the one hand, conditions leading to oversupply are correcting in that Canada’s market continues to expand and producers have slowed if not curtailed expansion plans. On the other, when adjusted for the write-down gross profits were positive.
The Technical Outlook: Cronos Is Poised For Profitability But Price Action Is Mixed
The Cronos report confirms bad news but it’s bad news we already knew about. What it also confirms is the market may be bottoming. Oversupply issues persist but are coming into alignment and, even if they don’t, efficiencies within the operations are offsetting margin decline to some degree. Keep in mind that the 2nd quarter results included strategically-sound CAPEX increases and the company’s well-capitalized balance sheet. Unlike so many other cannabis companies, Cronos opted not to lever-up to drive growth so there is virtually no debt to worry about either.
Looking at the charts, shares of Cronus fell pretty hard following the earnings release but are already showing signs of life. Today’s report from Canopy Growth Company reinforces the idea that select cannabis companies are indeed on track to produce real profits. For now, support appears solid in the range of $5.00. A move above $7.00 would be mildly bullish, a move above $8.00 very bullish.
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