Will this recently announced acquisition finally make Canopy’s growth profitable?
Canopy growth (NASDAQ: CGC) struggled to break even for years. Under the leadership of Bruce Linton, then CEO, the company focused primarily on growing sales and finding new opportunities for the long term. However, now that sales growth is more difficult to achieve and the pandemic is shining a light on struggling companies, investors are not so willing to overlook a poor result.
This puts pressure on a company like Canopy Growth to start producing better results. It has laid off staff and closed some of its facilities in an attempt to simplify itself. More recently, the company announced its intention to acquire Supreme Cannabis (OTC: SPRWF), a decision that she believes will help her achieve her profitability goal. Should investors believe it?
Why Canopy Growth Says Supreme Will Help Boost Results
On April 8, Canopy Growth announced that it would acquire Supreme Cannabis for C $ 435 million ($ 348 million) in a share-based transaction. One of the main benefits of the deal for Canopy Growth is the acquisition of Supreme’s brands, including 7ACRES, which it has identified as one of the “leading premium brands” in Canada. Supreme’s low-cost hybrid greenhouse in Kincardine, Ont., Is another reason Canopy Growth investors can expect to see improved results for the company. By selling more premium brands and operating with better margins, the company could produce better results. Within two years, companies expect to achieve cost synergies of C $ 30 million.
What the numbers say
Supreme released its results for the second quarter of fiscal 2021 on February 11, reporting positive Adjusted EBITDA of C $ 3.6 million for the period ending December 31, 2020. During the prior period, its Adjusted EBITDA profit was slightly over CA $ 300,000. Its gross margin (before fair value adjustments) in the second quarter was 46% of net sales, which is certainly much better than the 16% margin that Canopy Growth reported on February 9 in its third quarter results, also for the last three months of 2020.
But Supreme has not been consistent in its results. In the first quarter, which ended September 30, 2020, its gross margin was C $ 2.2 million negative after depreciation charges of C $ 8.4 million pulled the company into the red. However, what is positive is that after adjusting for this, its gross margin before fair value adjustments was 53%, higher than the 41% margin the company had achieved a quarter earlier.
The data certainly suggests that the acquisition of Supreme may help improve Canopy Growth’s finances. But the impact on the financial results of the Canadian cannabis producer may not yet be so significant. Over the past two quarters, Supreme has generated only C $ 30.2 million in net income. In the last quarter alone, Canopy Growth’s net sales were more than five times that figure, at C $ 152.5 million.
Will this acquisition make Canopy Growth profitable?
Given Supreme’s small size, simply integrating the company into Canopy Growth’s business is unlikely to be enough to make the Canadian pot giant profitable. In the third quarter, Canopy Growth’s adjusted EBITDA loss was Cdn $ 68.4 million. Even with Supreme’s higher margin products, the acquisition alone will not allow Canopy Growth to break even. While it is true that this will improve the profitability outlook for the company, I do not see any material impact unless Canopy Growth attempts to increase Supreme’s production scale. And that, of course, would increase costs and offset some of the additional revenue growth.
Canopy Growth still has a lot of work to do to clean up its own operations to meet its positive Adjusted EBITDA target by the second half of fiscal 2022, which is about a year away.
Should you invest in Canopy Growth based on this acquisition?
Supreme adds value to Canopy Growth’s business and could help improve its long-term operations. However, the stock is still insanely overvalued: investors are currently paying more than 25 times their income. Even if you add in the revenue rate of C $ 80 million that Supreme is currently at, that would only bring its multiple down to just under 23. In comparison, the Rivals Aphria and Cannabis Aurora trade in multiples of around nine and five, respectively. While this acquisition is a positive step forward for Canopy Growth, pot stock is still too expensive to buy at its current valuation, especially since profitability is by no means a guarantee.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.