Marijuana ETF rallies after Canopy Growth reports earnings

• Canopy Growth rallied Friday morning after the company reported that third-quarter sales rose 282 percent over the past 12 months.
• Profit was boosted by the company’s first sales of legal recreational marijuana in Canada, which accounted for more than 70 percent of gross revenue.
• The company missed profit expectations because operational costs remain elevated compared to peers, according to a top analyst.

Cannabis producer Canopy Growth rallied Friday after it reported third-quarter revenue rose 282 percent over the last year in what represented one of Wall Street’s first looks into the legal recreational marijuana market in Canada.

Here’s how the company did compared with what Wall Street expected when it reported earnings on Thursday:

• Net loss per share: 38 Canadian cents ($0.28) vs. a loss of 16 Canadian cents expected by analysts polled by Refinitiv. That compared with net income of 1 Canadian cent per share in the year-ago period.
• Revenue: CA$83 million ($62.5 million) vs. CA$81.2 million expected by analysts polled by Refinitiv. That compared to net sales of CA$21.7 million in the year-ago period.
• Canopy sold 10,102 kilograms of pot and equivalents during the fiscal third-quarter. Of that total, the company sold 7,381 kilograms of recreational cannabis in business-to-business transactions and 1,611 kilograms of medical cannabis.
• Chief Financial Officer Tim Saunders has informed the company of his decision to retire from that position in mid- to late-2019.

Despite missing profit expectations, investors appeared relieved by the sales numbers, which were supported by sales of legal marijuana in Canada. Revenue numbers fell short of expectations in the prior quarter. The stock rallied 3.5 percent shortly after the opening bell Friday.

Hoping to address sector supply shortages and steep demand, the company said in a press release that it placed “significant focus” on shipping core products into retail locations in the third quarter. Oils, including the company’s popular softgel capsules, accounted for 33 percent of product revenue for the three months ended Dec. 2018.

“The Canadian recreational cannabis market will be dominated in the long term by businesses delivering excellent products and consumer experiences,” Canopy CEO Bruce Linton said in a press release Thursday. “Sales from the first wave of products and retail environments launched in the third quarter demonstrate that we are capturing consumers’ attention.”

Canopy also introduced new products such as oral cannabis sprays and pre-rolled joints made by its custom-built, proprietary automated cannabis rolling machines at its headquarters in Smiths Falls, Ontario. Still, operational costs remain elevated at Canopy when compared to peers, said top cannabis analyst Vivien Azer, and likely contributed to the profit miss.

“While industry disclosure around gross margin can vary from company to company, for Canopy, cash cost of goods sold per gram of $5.11 looks to be meaningfully higher than its peers, having climbed 15 percent sequentially,” Azer wrote in a note to clients. But “from a gross revenue perspective, adult use was a much bigger contributor than we had modeled, accounting for 86 percent of sales.”

The past few months have been eventful for the cannabis industry as a whole and Canopy in particular.

In the United States, the $867 billion farm bill signed into law in December included a provision for industrial hemp legalization that Senate Majority Leader Mitch McConnell, R-Ky., had introduced. The provision removed industrial hemp from the federal government’s list of controlled substances, making it a lawful agricultural commodity.

That legislative development has acted as a sort of catalyst for many of the largest cannabis companies, which can now extract cannabidiol (CBD) from hemp in the United States. CBD, a chemical compound found in both marijuana and hemp, is a non-psychoactive agent claimed to have a wide range of health benefits, including a calming effect.

How the compound is consumed, however, remains a point of confusion and safety for many regulatory and law enforcement agencies. The U.S. Food and Drug Administration prohibits companies from adding the active ingredients in drug products to foods and beverages. CBD falls into this category because it’s the main ingredient in Epidiolex, a drug the regulator approved last year to treat severe childhood epilepsy.

Still, the farm bill and its impact on hemp production acted as a trigger for Canopy Growth. The company was granted a license by New York state to process and produce hemp with the help of Democrats Gov. Andrew Cuomo and Sen. Charles Schumer.

Depending on board approval of a specific site, Canopy plans to invest between $100 million and $150 million in its New York operations, “capable of producing tons of hemp” on an annual basis. It plans to locate its new operation somewhere in southern New York, putting it in close proximity to international alcohol giant and business partner Constellation Brands.

Canada became the first Group of Seven country to approve the recreational use of cannabis on Oct. 17, though each of the country’s 10 provinces are able to regulate the market. Marijuana use is still illegal in the United States at the federal level, though many states have passed laws legalizing the use of cannabis for medical or recreational uses.