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Can These Beaten-Down Growth Stocks Be Revived?

The S&P 500 has dipped 18% so far this year, but this distressed market creates opportunities to buy excellent stocks in industries with massive potential. Marijuana is one such sector. The global legal marijuana market could grow at a compound rate of 25% by 2030, according to Grand View Research.

However, Canadian cannabis stocks are struggling to grow revenue and earn profits, which is pulling down their stock prices. One-time investor favorites Canopy Growth (NASDAQ: CGC) and Aurora Cannabis (NASDAQ: ACB) have seen their stocks dip more than 90% in the last three years.

Aurora and Canopy have been in pursuit of positive earnings before interest, taxes, depreciation, and amortization (EBITDA) for quite a while now, but have failed to reach their goal. Investors who already hold the stocks might be wondering whether it is time to sell. Let's dig in to determine if these beaten-down growth stocks can come back to life anytime sooner.

Image source: Getty Images.

Canopy Growth

Canopy's fourth-quarter and fiscal-year 2022 results did not please investors. Fiscal 2022 net revenue declined 9% to 520 million Canadian dollars ($403 million) from fiscal 2021. Canadian recreational business fell 10%, while its medical cannabis business dipped 5% year over year.

Management stated in the earnings call that transitioning its product mix to focus on premium products caused this dip in revenue. The company said industrywide pricing pressure brought down its gross margin for the year, which came in at a negative 37%. Besides regulatory delays, rising competition has also led to many smaller players reducing their prices to attract consumers, thereby affecting overall sales.

As a result, its adjusted EBITDA loss came in at CA$415 million, versus CA$340 million in the prior year.

It secured a strong partner to do its financial heavy lifting when U.S. beverage giant Constellation Brands invested CA$245 million in Canopy in 2017. It owns a 38.6% stake in Canopy.

It ended the quarter with cash and cash equivalents of CA$776 million and short-term investments of CA$595.7 million. This partnership has kept Canopy safe for now, but it has to work on its top line to be a profitable pot stock.

Canopy recently launched an array of recreational offerings under its 7Acres, Ace Valley, Deep Space, and Doja brands. These products include cannabis flowers, beverages infused with tetrahydrocannabinol (THC), pre-rolled joints, and some new offerings for craft cannabis connoisseurs. Investors have to wait and see if these new products will help Canopy boost its revenue. It continues to reduce its selling, general and administrative expenses, which fell 18% to CA$472 million compared to fiscal 2021.

Aurora Cannabis

Not much has changed for Aurora this year. In its recent third quarter (ended March 31), revenue fell 9% year over year to CA$50 million. Its consumer cannabis revenue took a drastic hit of 43% to CA$10 million, driven by industrywide pricing pressure, according to management.

Its medical cannabis revenue jumped 8% to CA$39 million from the year-ago period, but it was not enough to bring in profits. This overall dip in revenue led to another quarter of EBITDA losses, which stood at CA$12 million -- no surprise there.

Aurora has repeatedly failed to meet its EBITDA target in the last two years. But yet again, the company did not shy away from reassuring investors it would be EBITDA-positive by the end of fiscal 2023.

To make it happen, it has to grow revenue drastically while keeping costs lower, which I doubt is possible anytime sooner.

Management discussed its plan to launch 40 new products (medical and recreational) between April and July to boost revenue.

Aurora is smart to launch new products to keep up with its peers and the expanding cannabis market. But launching products involves spending money, and the company has proved it is not very good at that. It claims to have the strongest balance sheet in the industry with CA$455 million in cash. But most of it has been raised by issuing new shares. From total outstanding shares of about 100 million at the end of March 2020, it has now gone up to 215 million shares as of the quarter ended March 2022.

A wait-and-see approach

Besides Constellation, Canopy has pending partnership deals with Acreage Holdings, Wana Brands, and Jetty Extracts, which will be finalized whenever U.S. federal legalization comes to fruition. Aurora doesn't have any strong partners in the U.S. yet, but it acquired hemp-derived CBD company Reliva in 2020.

Canopy and Aurora both have high expectations from the U.S. cannabis market. But it is a long shot as domestic pot companies (some of which are profitable) will be the first to benefit from federal legalization (if and when that happens). I believe that to grow revenue now, both should focus on the Canadian and the European markets, where they have an established presence. Estimates show the European market could grow at a compound annual rate of 29.6% to $37 billion by 2027, according to Research and Markets.

All hope is not lost for Canopy and Aurora, but it could take a long time before either could see green on their bottom line. The average Wall Street analysis has an underperform rating for Canopy with a hold rating for Aurora. I would advise you to steer clear of these two until they show a couple of quarters' worth of positive adjusted EBITDA and strong sales growth. For those interested in cannabis stocks, the U.S. domestic players are a much better option with outstanding financials and long-term prospects.

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Sushree Mohanty 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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