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3 Burning Questions for Canopy Growth

It has been an all-out disaster for cannabis producer Canopy Growth (NASDAQ: CGC) this year. Down more than 70%, it has performed far worse than the Horizons Marijuana Life Sciences ETF, which has fallen by 44%. For the pot stock to turn its fortunes around, its business will need to perform a whole lot better than it has in the past.

Canopy Growth reports its latest earnings numbers on Friday, and there are three important questions investors should be looking for answers to before deciding whether to invest in it.

1. Will sales nosedive amid inflation?

A big challenge for even the largest companies in the world these days is finding ways to increase sales while also dealing with inflation. But Canopy Growth’s problems go further back than inflation; the company has been struggling to generate consistent growth for the past few years:

CGC Revenue (Quarterly) data by YCharts.

Now, with inflation being a huge problem and consumers cutting back on nondiscretionary spending, my concern would be not just whether sales will rise but how sharply they may decline. Canopy Growth could be a dangerous stock to be holding during this downturn. The company’s strategy to battle inflation and generate sales growth is something investors should seek answers to.

2. Can it improve on its dreadful gross margin?

Another problem that inflation will likely exacerbate is Canopy Growth’s low margins. In fiscal 2022, Canopy Growth reported a negative gross margin of 37% for the year ending March 31. Even on an adjusted basis, it was still negative 11%. Last quarter, the company blamed restructuring charges, higher shipping costs, and declining prices for an especially abysmal period in which its gross margin was negative 142%.

Investors shouldn’t expect miracles here; the company isn’t likely going to report a positive gross profit this quarter. However, there should be some effort to improve on this. While inflation will give Canopy Growth a justification for a bad gross profit result this quarter, that should incentivize the company to be more diligent in finding a way to improve it. Otherwise, a possible slump in sales compounded by worsening gross margin could pave the way for even steeper declines for the stock in the months ahead, because inflation doesn’t appear to be going away anytime soon.

3. When will the cash burn stop?

Declining revenue and low margins can also put pressure on cash flow. That, too, hasn’t been a strong point for the business. The only reason Canopy Growth is in a good financial position today stems from the $4 billion investment alcoholic beverage giant Constellation Brands made in the pot producer in 2018. But Canopy Growth’s cash balance has been depleting over the years and worsening results could mean that in the near future, the company may need to go the route of other serial diluters in the industry and raise significant money through stock offerings.

CGC Cash and Equivalents (Quarterly) data by YCharts.

Cash burn has unfortunately been the norm for Canopy Growth’s business and this problem goes hand in hand with its low gross margin. Becoming more efficient and profitable will be key to this becoming a stock that investors will seek out rather than avoid.

Until the company can adequately answer these questions and provide some proof through its numbers that it’s on the right track (rather than through assurances and glowing forecasts for the future), investors should remain extremely cautious with this business. Although there’s long-term potential in the cannabis industry, Canopy Growth may not be able to capitalize on it if its financials remain in disarray.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Constellation Brands. The Motley Fool has a disclosure policy.

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