Production and staff cuts make the CGC share look really risky

<p>Canopy Growth (NYSE: CGC) is the world’s largest cannabis producer with market value, but it will be a little smaller in terms of production capacity and number of employees. The CGC share is in for a long spring.

Source: Shutterstock

Last week, Canopy announced its biggest move since its founder and co-CEO was fired in July last year.

Under a new “production optimization plan”, Canopy eliminates 500 positions and closes two greenhouses with a total of 3 million square meters of production space. The CGC share slipped nearly 26% in the three days after the announcement and hit downwards not seen since 2017.

The last time I wrote about Canopy Growth was in mid-January. At the time, the stock had put together a run that saw it gain 21% in less than a week and approach the $ 25 level. But the streak soon squirted.

There has been a decline of 50% since then and definitely answered the question of how long the rally would last. That decline was only exacerbated by the market reaction to Canopy’s cuts.

Canopy Growth’s production optimization plan

On March 4, Canopy Growth announced a “production optimization plan” for Canada. This corresponds to the closure of two greenhouses in British Columbia that have been in operation since February 2018. The move reduces CGC’s production capacity by approximately 3 million square meters.

Here is the company’s explanation for why it made the decision to close these greenhouses:

“Almost 17 months after the creation of the legal market for adult use, the Canadian leisure market has developed more slowly than expected, creating working capital and profitability challenges in the industry. In addition, federal rules were introduced that allow outdoor cultivation after the company made significant investments in greenhouse production. The company now operates an outdoor production facility to enable more cost-effective cultivation that will play an important role in meeting the demand for certain products that depend on cannabis extracts. ”

In addition, the CGC has abandoned its plan to add another production greenhouse in Niagara-on-the-Lake. As a result of the closures, approximately 500 positions will be eliminated. Canopy Growth says it expects a pre-tax hit of $ 700 million to $ 800 million in the quarter ended March 31.

CGC shares closed at $ 17.75 on March 4 before the announcement. It went down immediately and reached $ 13.22 on Monday.

Conclusion on CGC stock

Normally, the market reaction seems clear. However, these times are anything but normal. This means that the CGC’s results from 4 March cannot necessarily be attached to the announcement of closures and redundancies of greenhouse gases.

The problem is that there are two other factors at play. The first is the unrest in the market caused by fears of coronavirus from China in combination with an oil price war. The two scares resulted in the Dow Jones Industrial Average’s worst day since 2008 on Monday.

The second issue is cannabis industry specific. The cannabis 2.0 boost we were hoping for in the Canadian marijuana market has not yet been realized. The continued pressure on cannabis stocks began last spring when it became clear that the Canadian marijuana market would seriously underperform expectations.

CGC fell to $ 13.22 on Monday for a 26% loss on three-day trading. However, Aurora Cannabis (NYSE: ACB) decreased by 27.5% during the same three days. This suggests that the broader market forces are behind the CGC decline.

In the end, the crucial move from Canopy Growth’s new CEO is likely to pay off.

The company will charge fees related to the cuts, but in future there will be 500 fewer employees on the salary. And there was no point in maintaining expensive production facilities if demand was not there.

If needed, the capacity can be increased to a lower cost outdoor space instead. It may (or may not, depending on how you read these tea leaves in recent days) have damaged the CGC share in the short term, but lower operating costs give the company a step closer to possible profitability.

It is possible that once we have gone through the worst of coronavirus and Canada’s launch of cannabis 2.0 has increased, the CGC share price may start moving in the opposite direction. If all goes well, it could even reach the average price target of $ 23.58 as investment analysts asked by The Wall Street Journal.

At the time of writing, Brad Moon had no position in any of the above securities.