Recognizing the positives that are present in a generally negative situation is a key skill in investing and in life. It’s also a skill that many cannabis investors, particularly in companies like Canopy Growth, (CGC 10.12%) have had quite a few opportunities to master in recent years.
Now, Canopy’s shareholders will have yet another chance to practice finding the good, just in time for 2024. Let’s discuss the latest grim tiding for the stock, and then round it out with appreciating a pair of much-needed silver linings.
When neutral news is actually bad news
One of the somewhat mysterious properties of stocks is that their valuations are affected by both stock splits and reverse stock splits. Mathematically speaking, that doesn’t make much sense. If a company has a market cap of $1 billion and it has 100 shares outstanding, doubling or halving the number of shares “should” only change the price per share, not the market cap itself. Put differently, whether you slice a pie into eight slices or only four, the pie is the same size either way.
So when Canopy Growth said on Dec. 13 that it would do a reverse stock split on Dec. 20, in which 10 of its shares would be consolidated into just one, why did its stock crash by 33% over the following five trading days?
The answer to that question is that companies seldom opt to do a reverse split if they aren’t being forced to. Â In early December, before the split, Canopy’s shares reached a high equivalent to about $8; after the plunge they traded at a recent price of $5.14. If a stock’s share price falls below the listing requirements on the stock exchange — which for the Nasdaq, Canopy’s exchange, is a minimum of $1 per share — it can get delisted after a period of time.
Delisting is a catastrophe for investors, because it deprives stocks of a significant volume of daily trading, among other problems, hence the need to maintain a minimum stock price by pursuing a reverse split. Consolidating the number of outstanding shares means that each share is worth a higher price.
Reverse splits don’t occur in a vacuum. Canopy’s shares have fallen 98% during the past three years, and the company is in trouble. In that period, its quarterly losses grew significantly, and its quarterly revenue fell by 56% to reach $52 million. The company is unprofitable, and it doesn’t have enough cash on hand to cover its trailing 12-month (TTM) total operating expenses of $268 million.
There’s more than one culprit for those issues, most of which stem from Canopy’s overbuilding of cannabis cultivation, manufacturing, distribution, and retail operations during the Canadian marijuana market’s heyday a few years ago. Since then, it’s been working to unwind its excessive footprint via closures and divestments, and it’s sold seven of its facilities since April 2023 alone.
Unfortunately for shareholders, those actions probably won’t be enough to save them, regardless of the higher share price caused by the reverse split. As investors broadly understand that struggling companies are more likely to need to do a reverse split to stay listed on their exchange, the fact that a company does a reverse split at all is a strong sign that severe struggles are unresolved. Sentiment about Canopy is now definitively in the gutter, and it’s not clear if or when that’ll change.
A couple of shreds of good news too
On the bright side, Canopy Growth was able to accomplish something positive recently when it sold a pair of its underperforming business units.
At the start of December, it closed a deal to offload its BioSteel sports drinks business for 30 million Canadian dollars ($22.5 million), which is especially good because it had been burning money at an accelerating pace. Alas, the company now has one fewer growth driver to prop up its sagging top line, but the effect on its margin should be visibly favorable within a quarter.
Then, on Dec. 18, it said that it had also sold its This Works brand of skincare products for CA$16 million. The products associated with the brand weren’t exactly star performers, so it makes sense to shed them during the business’ streamlining process. The cash from both the divestitures will help to keep the lights on for a while longer while the company attempts to right-size itself.
Overall, these silver linings don’t do much to restore Canopy Growth to its former glory, nor do they support any kind of investing thesis for buying the stock. Avoid this one until there’s a turnaround to invest in.
Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
