Canopy: Slashing Fair Value Estimate and Increasing Uncertainty Rating as Massive Dilution Coming

After reviewing Canopy’s WEED fiscal fourth-quarter results, we are drastically cutting our fair value estimates to $0.80 and CAD 0.90 per share from $6 and CAD 8, respectively. The major drivers of these revisions are continued challenges in the Canadian legal cannabis market, the execution of Canopy USA as currently proposed, and the massive amount of debt coming due over the next few fiscal years. In addition, we affirm our no-moat rating, raise our Morningstar Uncertainty Rating to Extreme from Very High, and lower our capital allocation rating to Poor from Standard. Although shares trade below our fair value estimates, we caution that there is a high risk of further declines after a 25% drop last week.

The first factor in our reduced valuations is a reduced profit outlook for the Canadian THC operations, as we lower our long-term gross margin estimate to 43% from 50% due to the stubborn challenges in Canopy’s home market.

Second, we no longer include U.S. THC revenue in our model, as the current structure of the proposed Canopy USA deal will not allow Canopy to consolidate financials or have any direct control. Thus, we now include Canopy USA as an equity stake in our fair value estimate calculations although a lack of disclosure complicates matters.

Lastly, our fair value estimates are impacted by the likelihood of material dilution to existing shareholders. Since the end of the first quarter, diluted shares outstanding have risen 25%, and we think Canopy will need to issue even more shares to address its looming debt maturities, including CAD 468 million in fiscal 2024 and CAD 788 million in fiscal 2026. Although the company had CAD 783 million in cash and securities at the end of fiscal 2023, the company continues to burn cash and has yet to reach EBITDA profitability. Further, the inability to draw revenue from Canopy USA makes dilution even more likely.