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Canopy Growth could be hit with higher-than-expected costs from edibles and drinks: BMO

Staff work in a marijuana grow room that can be viewed by at the new visitors centre at Canopy Growths Tweed facility in Smiths Falls, Ont. on Thursday, Aug. 23, 2018. THE CANADIAN PRESS/Sean Kilpatrick

Canopy Growth Corp.’s (WEED.TO) much-anticipated lineup of edibles, drinks and vapes could mean higher than expected costs for the company, according to analysts at BMO Capital Markets.

“We believe the operating expense needed to ramp manufacturing and processing capabilities in fiscal 2020 could be higher than expected. As a result, we have materially lowered our EBITDA forecasts in fiscal 2020 and fiscal 2021,” Tamy Chen and Peter Sklar wrote in a research note on Sunday.

The pair are calling for Canopy Growth’s loss before interest, taxes, depreciation and amortization (EBITDA) to amount to $314 million and $77 million in 2020 and 2021, respectively.

The largest cannabis company by market capitalization reported fourth-quarter earnings last Thursday. Net revenue climbed to $94.1 million from $22.8 million a year earlier. Net loss attributable to shareholders jumped to $323.4 million or 98 cents per share for the quarter, compared with a loss of $61.5 million or 31 cents per share during the same period a year ago. EBITDA in the period ended on March 31 was negative $98 million, compared with a $21.7-million loss a year ago.

New regulations for edible, drinkable and topical cannabis products officially come into effect on Oct. 17, one year after Canada legalized recreational cannabis. The first products are expected to be available for sale in mid-December.

Chen and Sklar “remain cautious on meaningful revenue contribution from value-added products” into the fourth quarter of 2020, warning that Health Canada’s 60-day review period could force companies to make changes and delay product roll-outs.

Speaking on a conference call with analysts on Friday, Canopy Growth’s acting Chief Financial Officer Mike Lee said costs associated with developing and laboratory testing edible and beverage products contributed to expenses ballooning by 332 per cent year-over-year in the fourth quarter.

Co-Chief Executive Officer Bruce Linton said Canopy Growth has been investing heavily for long-term growth, and noted there is “a bit more spend to go.”

“The finish line will be products measured in two to 10 milligrams in a beverage that will be unique, differentiable, (and) we believe, highly brandable,” he told analysts on Friday.

He said the company will be ready to submit photos to Health Canada for approval of its beverage platform as soon as June 28, and beverage-related construction will be complete by about mid-September.

‘Gross margin should improve’

Analysts have raised concerns about weakening gross margin at Canopy Growth.

Adjusted gross margin fell to 16 per cent in the fourth quarter, from 22 per cent in the previous period. Linton said he believes the company is on track to report a gross margin above 40 per cent by the end of the fiscal year.

“You've seen, I think, the bottom of our margin trough,” he told analysts.

Chen and Sklar have a “market perform” rating on Toronto-listed Canopy Growth shares, and a price target of $60, down from their previous target of $65.

Shares fell 3.47 per cent to $51.43 at 11:08 a.m. ET.

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