You Are Expected To Select A Company And Three Competitors From The Same Industry And Prepare An Analytical Report In Which You Will Critically Evaluate, Analyse, Discuss And Comment On The Key Issues In The Financial Appraisal.

Introduction

The following report highlights the financial performance of Canopy Growth Corp (CGC), a TSX traded company, in the emerging market of legal marijuana production both in Canada and abroad. The report covers the current financial health of the company, its strengths and weaknesses using varied financial ratios and horizontal and vertical analyses, and how it compares to other companies within the pharmaceutical preparations industry. Additionally the report provides an assessment of the marijuana “industry” as a whole, insights as to the limitations of the types of analyses I have chosen to use and lastly, some informed recommendations for CGC going into the future using all of the research presented.

Current Business and Financial Health

CGC has had a big year in 2016 seeing its assets grow from $47.8M to $143.4M between the last two annual reports (a 300% increase) and a further $52.8M (and an additional 110% increase since 2015) in the last two quarters which are mostly attributable to acquisitions of Canadian companies Vert Medical and Hemp.ca as well as German company MedCann all dealing in cannabis or hemp production and distribution. The acquisition of Bedrocan in August 2015 has also led to in intangible assets and goodwill totaling $51.58M combined appearing on financials for 2016. Debt financing has been a challenge for many marijuana affiliated companies as commercial lenders are risk adverse with markets that may skirt legal frameworks on a touchy subject, however CGC successfully secured $5.5M for facilities investments in making it the first cannabis company in Canada to hold multiple financings with commercial lenders, which is seen as a huge vote of confidence for the company’s business practices (CNW Telbec, 2016, para. 1-3). CGC’s Board of Directors has deliberately not distributed any dividends while they are still in a growth phase.

Profitability ratios are negative for CGC (Fig 1), however they are much better compared to industry within the TSX and the financial trends for the company (Fig 2 & 3) show steady increases in gross profit, as well as a net income that saw positive numbers in the latest quarter.

Fig. 1 Profitability Ratios for Canopy Growth Corp and Industry in Q2 for 2017

Fig. 2 Financial Trends for Canopy Growth Corp from Annual Reports 2015 to 2016

Fig. 3 Financial Trends for Canopy Growth Corp over last 4 Quarters

Overall, with a total debt to equity ratio of 4.34 % compared to an industry ratio of 314.65%, CGC has done very well to balance their company’s financing on shareholder’s equity instead of relying heavily on debt. This is partially as mentioned above due to the challenges for cannabis related companies to secure financing, and it is to be noted that the broader industry ratio represents all pharmaceutical manufacturing companies listed on the TSX. Notwithstanding the cause, CGC’s has kept leverage low having over 20 times more assets financed by equity than debt.

Furthermore, despite past performance of negative income (Fig 2 & 3), CGC’s quick ratio is 5.47 showing more than adequate liquidity to cover short term liabilities which is even better than the industry’s quick ratio of 4.47. CGC was founded in 2014 following the Canadian legislation to allow private and public companies to obtain licenses to produce marijuana for medical and research purposes (Government of Canada, 2012). Having only been licensed and operating for little over 2 years, CGC is still in a growth phase of development where the costs of revenues has been higher than the net revenue, although the upward trend of net revenue is close to breaking through to positive numbers (Fig 4). Considering the trend lines in figure 4, it would not be surprising to see CGC start returning a profit margin in the third quarter of fiscal year 2017.

Fig. 4 Canopy Growth Corp Total Revenue vs Cost of Revenue trends last 4 quarters

Canada is about to release legislation in April 2017 that is expecting to see nationwide legal recreational consumption of cannabis beginning as early as January 2018 (Cullen, 2016, para.13). Despite CGC being registered as a pharmaceutical manufacturing company that only sells cannabis for medical and scientific purposes, consumption of legally produced marijuana for adult recreational purposes is standing by to multiply sales of legal marijuana in the near future, and CGC is perfectly placed to pick-up consumers from that market. CGC acknowledges this fact directly in their company financial reports and are positioning to benefit from the new market (Canopy Growth Corp Management, 2016, p. 8).

A quick look at US recreational marijuana sales shows the strong potential in the adult use recreational cannabis market between 2014 and 2015 (Fig 5.)

Fig. 5 US National Adult Use Sales Growth (The State of Legal Marijuana Markets 4th Edition Executive Summary, 2016, p.9)

CGC has a strong debt to equity ratio, positively trending revenue, financial support from commercial lenders and many strong acquisitions completed or about to be completed in 2016 that multiply their access to consumers. It has established strong momentum to start seeing positive gross profits and is very well positioned in a market that is growing aggressively and will continue to grow with the allowance of recreational use marijuana.

A Researched Evaluation and Critical Analysis of Industry Sector and Financial Competitor Analysis for Three Listed Companies in the Same Sector (using Organigram Holdings Inc., GW Pharmaceuticals Plc, and Plandai Biotech for comparisons)

The cannabis industry sector is not uniquely defined in the business realm due to the cross over into many other defined industry sectors involved in the production, preparation and distribution of cannabis. This is best observed using a website that is tracking 37 marijuana related stocks that are registered under no less than 19 different Standard Industry Codes (SIC) (List of Marijuana Stocks, 2015). However, the overall trend for sales of cannabis for both medical and recreational adult use purposes following legalization has trended only in a positive direction as demonstrated in US market research (The State of Legal Marijuana Markets 4th Edition Executive Summary, 2016, p. 9) as well as in CGC’s own financial reports that graph consumer increase, and sales increases over time (Canopy Growth Corp Management, 2016, p. 16). In order to provide a relative comparison of companies in this report, the four being compared are listed under SIC 2834 covering pharmaceutical manufacturing and all develop and distribute medical marijuana.

Altman Z-Scores

Using Altman-Z scores, which is has been a reputable method for predicting bankruptcy since it was developed in 1967, gives a good snapshot of CGCs position in the market (Fig 6).

Fig. 6 Altman-Z Score for Pharmaceutical Manufacturing Companies Involved in Cannabis

CGC and Organigram Holdings both show Altman Z-scores comfortably in the safe zone above 3 as predicted by the model (Altman Z-Score, 2016). GW Pharmaceuticals is within the risk of bankruptcy range of 1.8-3, but at least is within the higher range. As for Plandai, it is losing money by the quarter and with negative numbers for working capital, retained earnings and earnings before interest and tax (EBIT), it is growing in debt. Plandai has growing debt, and very few assets to show for it by comparison giving a DTA of 226%. They have also changed accounting firms close to every year over the last 7 years, so their liability and expense numbers are jumping around their financial reports. Based on the Altman Z-Score predictive score of -4.19 it is a wonder why Plandai has not gone bankrupt yet. Further investigation is required to take a deeper look as to why Plandai is doing so poorly, but that is beyond the scope of this report.

Profitability Ratios

As mentioned above, CGC is not yet showing profitability in its ratios, however when compared below it can be seen that CGC is doing better than two of its market competitors in terms of inventory turnover (Fig 7).

Fig. 7 Profitability Ratio Comparison of Pharmaceutical Manufacturing Companies

Plandai Biotech shows strong for inventory turnover, however a closer look at their numbers has seen inventory go from $516,000 in 1990 to $95,000 in 2011 to $2286 in 2015 so for some unknown reason this botanical production company is dropping its inventories. Likewise with asset turnover, CGC’s sales show stronger asset turnover than GW Pharmaceuticals and Plandai, both UK based companies that trade in US markets. It is not in as good a position as Organigram; however the recent acquisition of many companies and their instantaneous asset growth has put CGC in a position that will skew its asset turnover ratio until it has time to start putting those assets to productive use. Also notable is a comparison of management ratios that do not show well for anyone in the industry (Fig 8). Plandai is doing very poorly, however due to the nature of looser financial reporting requirements for OTC market companies; some of the numbers quoted through online financial analysis with Investing.Com and Merchent do not necessarily represent hand calculated ratios. CGC stands out strong against GW Pharmaceuticals, however when compared to its Canadian market competitor, Organigram,

Fig. 8 Profitability and Effectiveness Ratios for Pharmaceutical Manufacturing Companies

its recent boom in shareholder investments, securing of commercial large commercial lending, and acquisitions of several other companies that increased asset levels rapidly, the ratio returns based on sales revenue show poorly while revenue has not had a chance to pick up. The great thing to note is how similar all of the return ratios are for CGC which demonstrates that the company has maintained and is showing good solvency as described in the next section.

Long Term Solvency

CGC’s debt to equity ratio, otherwise known as a gearing ratio, measures close to GW Pharmaceuticals, an established UK based producer and distributor of medicinal marijuana. A close look at Plandai’s financials actually show a negative equity ($-8.3M) owed to paid-in capital lent at a 6% interest rate to try and cover negative retained earnings ($-36.3M) and liabilities of $16.8M and therefore its gearing ratio of -185.19 is no surprise beyond why it is not bankrupt yet. In terms of DTA ratios, Canopy Growth is in the strongest position of all four companies reflective once again of using shareholder equity to finance assets, as well as the fact that many recent acquisitions have been made in exchange for common shares vice cash transactions strengthening the financed position of the company. Plandai is an outlier here once again, as their listed assets are small at $6.6M compared to their total liabilities of $16.8M. It is also to be noted that the majority of Plandai’s business is not in cannabis, rather it is concentrated in other botanicals like green tea extract supplements.

Fig. 9 Long Term Solvency Ratios for Pharmaceutical Manufacturing Companies

Short Term Solvency/Liquidity

CGC is showing a strong lead compared to its three industry competitors when it comes to its ability to cover current debts with is current assets as can be seen in Figure 10. Canopy Growth, along with Organigram and GW Pharmaceuticals could all pay their current debts multiple times over as shown with their acid test ratios, so there is no cause for concern with liquidity for any of those three.

Fig. 10 Liquidity Ratios for Pharmaceutical Manufacturing Companies

Plandai Biotech once again sticks out from the other three, as its asset levels are so low that the ratios work out to almost zero. This is a big indicator that the company might not avoid bankruptcy for long, especially with negative equity gathering interest, and with very few assets to show for it and its complete inability to pay its current debts as they come due.

A Critical Analysis of the Financial Strengths and Weaknesses of Canopy Growth Corp as Compared to its Industry Competitors

CGC has shown early strengths in the market based on its Altman Z-score both individually and compared to others in the pharmaceutical manufacturing industry. Interestingly, CGC has very low profitability which is reflected within the Altman Z-Score with negative values, however it is CGC’s extremely strong equity ratio of 7.97 that keeps its Z-score high making it a strong contender against bankruptcy risk.

Another weakness for CGC is its youth in the market as there are only two years of data on which investors can calculate their risks and there is typically a lot of financial volatility in the early years of companies. A comparison to Organigram however shows that CGC is the older of the two companies with greater assets and shareholdings, thus CGC can be considered more mature within the Canadian market. GW Pharmaceuticals was founded in 1998 in the UK and it specializes in two cannabis-based products, Sativex and Epidiolex, used by customers in over 29 countries over the past 15+ years (History and Approach, 2016). One would expect GW’s time in the market to have it in a much stronger position than CGC, and its numbers are larger, however on a ratio basis CGC is similar or better off than GW for profitability, leverage, gearing and liquidity.

When considering CGC’s lack of profitability, a simple two year horizontal analysis covering a vertical analysis using revenue as a baseline shows both the negative incomes, but more importantly the upward trends towards positive income in the very near future.

Fig. 11 Vertical Analysis of Canopy Growth Corp Expenses and Income Compared to Revenue

CGC’s acquisition activities have strengthened its production and distribution potential remarkably. Of note, the acquisition of Germany’s MedCann has created an entry into the established but nascent European medicinal marijuana market. The acquisition of Quebec’s Vert Medical and Ontario’s Mettrum Health will expand CGC’s regional control of the market. As well, it has become a majority holder in Quebec’s hemp producer Hemp.ca Inc. (Israel, 2016) diversifying its product line. Also of note is CGC’s partnership with AusCann Group Holdings Ltd. announced in May of 2016 which brings CGC into the emerging Australian medical cannabis market and a third continent (CNW, 2016). Lastly, CGC formed a partnership with a Brazilian Entourage Phytolab and created a joint company, Bedrocan Brazil, through which it imports CGC varieties of cannabis to Brazil for medicinal purposes (CNW Group, 2016; Canopy Growth Corp Management, 2016, p. 9). Each acquisition has seen CGC’s assets and equity rise, and its global footprint expand making its potential for profit one if its greatest strengths that directly addresses its most outstanding weakness.

A Critical Evaluation of Financial Techniques Used

The Altman Z-Score has been proven to demonstrate companies’ risks of bankruptcy by the very nature that it was established based on the financial statistics of 66 companies that operated between 1946 and 1965, and exactly half of them had declared bankruptcy (Altman, 1968, p. 593). It is likewise noted by Altman in his research that the model might not be ideal for young firms, considering specifically the retained earnings to total assets ratio: “a relatively young firm will probably show a low RE/TA ratio because it has not had time to build up its cumulative profits” (p.595). Although CGC still demonstrated a strong Altman Z-Score, the very fact that it is not even three years old yet and is not showing profits highlights a shortcoming in the Altman Z-Score in addressing the potential weaknesses of a young company.

Profitability ratios are not closely linked to liquidity ratios, although there have been attempts at drawing stronger conclusions between the two using the Pakistan oil and gas markets (Saleem & Rehman, 2011, p. 95). CGC has negative profitability ratios which bode very poorly for it when looked at from single snopshots, however when profitability ratios are trended over time they show much greater potential looking forward as profits are growing. It must also be noted that no trend will remain linear forever, so continuous review of new data compared to old must be done to make realistic assessments as to a young firms potential for profitability. Liquidity on the other hand is a very direct way of demonstrating a firm can pay its bills. A shortcoming within the liquidity realm for a corporation that deals in agricultural production is the ability to realistically calculate inventory turnover as the biological value of cannabis, the requirement to write off spoils, the dynamic pricing model, and the challenge to locate actual inventory numbers of similar products to compare them make inventory turnover a challenging tool for assessment.

Recommendations for Canopy Growth Corp and Conclusion

CGC is already doing a lot of the right things for success as a young company, including acquiring companies that have already done a lot of research and development, and already have strong and growing customer bases. It is already actively seeking out emerging legal medical marijuana markets around the globe to get involved in early and multiply its customer base outside the Canadian demand.

CGC needs to increase its profitability and start putting out positive income flow. This can be done by either increasing revenues, or decreasing expenses, or both. A closer look at the trend of customer growth (Canopy Growth Corp Management, 2016, p. 9) as well as CGC’s recent entries into European, South American and Australian markets shows that consumer numbers are going to continue going up in the near future so CGC must ensure it is ramping up its production at a similar pace to projected customer demand.

Similarly a look at CGC’s inventory production increases (p. 9) has demonstrated its increasing capacity to produce. In the first two quarters of 2017 CGC produced 2.2 kg of cannabis. A CIBC World Markets report projected the low end of recreational cannabis consumption in Canada to start at 770,000 kg annually, therefore CGC needs to ensure it is focusing its assets on production in balance with its lofty acquisition plans otherwise it will lose out on potential sales at home while shopping for business elsewhere.

Canopy Growth Corp has excellent debt management, strong shareholder support, well researched and established production capabilities and a slew of profitable acquisitions since its founding in 2014. It is considered to be still in a growth phase as expenditures have outpaced early profits and dividends have been avoided, however trends show potential for positive net income within the next fiscal year as all the investments in production expansion and broader distribution start realizing gains. Its biggest challenge will be keeping its production up with consumer demand while its competitors are still getting their footings in the emerging market of legal marijuana.

References

Altman Z-Score. (2016). Retrieved from Investopedia: http://www.investopedia.com/

Altman, E. I. (1968, September). Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy. The Journal of Finance, 23(4), 589-609. doi:10.1111/j.1540-6261.1968.tb00843.x

Canopy Growth Corp Management. (2016, November 13). Management's Discussion and Analysis of the Financial Condition and Results of Operations. Retrieved from Canopy Growth Corporation: http://www.canopygrowth.com/

CNW. (2016, May 20). Canopy Growth Corporation and AusCann Group Holdings. News Wire. Retrieved from http://www.newswire.ca/

CNW Group. (2016, June 28). Canopy Growth Corporation and Bedrocan Launch Brazil Joint Venture. MarketWatch. Retrieved from http://www.marketwatch.com/

CNW Telbec. (2016, August 5). Canopy Growth Secures $5.5 Million in Loan Facilities. Yahoo Finance. Retrieved from http://finance.yahoo.com/

Cullen, C. (2016, Nov 30). 8 burning questions about the coming federal pot report. CBCNews. Retrieved from http://www.cbc.ca/news/

Financials. (2016). Retrieved from Canopy Growth Corporation: https://www.canopygrowth.com/

Government of Canada. (2012, December 15). Marihuana for Medical Purposes Regulations. Canada Gazette, 146(50). Ottawa, Ontario, Canada: Government of Canada. Retrieved December 01, 2016, from http://gazette.gc.ca/

History and Approach. (2016). Retrieved from GW Pharmaceuticals: http://www.gwpharm.com/

Investors. (2016). Retrieved from Plandai Biotechnology: http://www.plandaibiotech.com/

Israel, S. (2016, December 2). Canopy Growth to merge with Canadian competitor Mettrum - Canada's biggest cannabis grower continues its string of acquisitions. CBC News.

Robertson, G. (2016, Dec 03). From Oxycontin to Medical Marijuana. Globe and Mail, pp. 10-11.

Saleem, Q., & Rehman, R. U. (2011, July 7). Impacts of liquidity ratios on profitability. Interdisciplinary Journal of Research in Business, 1(7), 95-98.

(2016). The State of Legal Marijuana Markets 4th Edition Executive Summary. ArcView Market Research & New Frontier. Retrieved from http:\\www.arcviewmarketresearch.com\

Appendix A – Formulas in the Order they Appear

Return on Equity (ROE)

Net Profit (- Preferred Dividends) / Average Common Shareholder’s Equity

Return on Assets (ROA)

Net Profit / Average Total Assets

Return on Investments (ROI)

Net Profit / Cost of Investment

Vertical Analysis with Revenue as a baseline

Any Income or Expense / Revenue

Altman Z-Score

Altman-Z = 1.2A+1.4B+3.3C+0.6D+0.999E where:

A = Working Capital/Total Assets

B = Retained Earnings/Total Assets

C = EBIT / Total Assets

D = Market Value of Equity / Total Liabilities

E = Sales / Total Assets

Inventory Turnover

Cost of Goods Sold (or Cost of Revenue or Production Costs) / Average Inventory

Asset Turnover

Net Sales / Average Total Assets

Gross Profit Margin

Gross Profit / Net Sales

Net Profit Margin

Net Profit / Net Sales

Debt to Equity

Total Debt / Total Equity

Debt to Assets (DTA)

Total Liabilities/ Total Assets

Acid Test Ratio

Current Assets – Inventory / Current Liabilities

Current Ratio

Current Assets / Current Liabilities

Millions of Dollars (CDN)

Canopy Growth

Corp (TSX)

Organigram

Holdings (TSXV)

GW Pharmaceuticals

Plc (NASDAQ)

Plandai Biotech

(OTC)

Gross Profit Margin-79.54%53.32%81.58%-265.92%

Net Profit Margin-28.98%5.65%-414.20%-2180.46%

ROE-4.90%2.87%-25.55%Not disclosed

ROA-4.35%1.66%-21.12%-59.83%

ROI-4.59%1.93%-23.69%Not disclosed