Fitch chops Canopy rating, citing cannabis producer’s Constellation link

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Canopy Growth’s planned entry into the U.S. marijuana market has hit another hurdle – this time over the cannabis producer’s ties to its largest investor.

Fitch Ratings downgraded its credit assessment of the Ontario, Canada-based Canopy to CCC-, one of its lowest ratings.

CCC carries “substantial credit risk” such that default is a real possibility.

It’s the second time in six months that Canopy’s credit rating has come under scrutiny from Fitch.

The New York-based ratings company said it believes the strategic link between Canopy’s biggest investor, alcohol giant Constellation Brands (CBI), and the licensed cannabis producer “has materially diminished” after Canopy announced its plan to speed its entry into the U.S. THC market.

“As such, Canopy’s ratings no longer benefit from a one-notch uplift from its standalone credit profile,” Fitch said.

In a statement to MJBizDaily, a Canopy spokesperson said Constellation Brands remains vested in Canopy’s success as a major shareholder “and fully supports this strategy as the best way to position Canopy for near- and long-term success.”

The spokesperson added that Canopy is making the move to take its destiny into its own hands by fast-tracking its entry into the U.S. marijuana market and taking full ownership of its investments there.

Constellation executives touched on their commitment to Canopy and the cannabis industry in a conference call with analysts on Oct. 6.

After being asked how long Constellation is willing to “wait” for U.S. legalization and how he views the alcohol company’s stake in the cannabis producer changing, Constellation CEO William Newlands said, “I wouldn’t expect you to see the size of our investment in that change.”

Newlands admitted he “failed miserably” in predicting the pace of U.S. legalization but also said he’s “hopeful” there will soon be progress.

In its latest update, Fitch said it downgraded the long-term issuer default ratings for Canopy Growth from CCC to CCC-.

Fitch also lowered the credit rating of the senior secured term loan facility from B/RR1 to B-/RR1.

Fitch’s action comes less than a week after Canopy announced a plan to speed its entry into the American market.

Rather than waiting for the United States to legalize at the federal level, Canopy launched Canopy USA, which would purchase the three American marijuana businesses Canopy had agreed to buy after the U.S. ended prohibition, pending various approvals.

Canopy’s proposal calls for Canopy USA, not Canopy Growth, to own the assets, and the Canadian business would hold nonvoting, exchangeable shares in Canopy USA.

“Fitch believes the transaction, as proposed, is subject to material execution risks including regulatory, shareholder and exchange approval,” the credit ratings agency said.

Stock exchange risk

Fitch isn’t the first to raise concerns about the deal.

The New York-based Nasdaq stock exchange objects to Canopy’s plan to eventually consolidate the financial results of Canopy USA.

By contrast, the Toronto Stock Exchange (TSX) suggested that the proposed structure is compatible with the exchange’s rules.

Neither the TSX nor the Nasdaq would answer specific MJBizDaily questions.

“Canopy’s credit agreement contains affirmative covenants to comply with all policies and listing requirements of public securities exchanges,” the Fitch notice acknowledged, adding: “A failure to remain listed on at least one exchange would be a condition for an event of default.”

Fitch noted that Canopy USA would need to maintain funding separate from its parent company.

“Fitch will continue to review Canopy’s corporate structure and exposure to U.S. THC assets that are federally illegal and whether that increases rating concerns,” the ratings company said.

Fitch also noted “significant execution risks” in Canopy’s premiumization strategy and an uncertain path to profitability, highlighting significant lost market share in Canada.

“This has delayed production of a consistent, higher-quality supply at commercial scale and generated weak operating results with an uncertain path to profitability,” according to the Fitch note.

“Canopy hopes to counter these issues with a change in its genetics and cultivation strategy to higher quality cannabis with the right attributes … for the premium and mainstream flower, pre-rolls, edible and vape markets, while using the value segment as an outlet strategy.”

On that point, Constellation’s executives said during the analyst conference call they continue to believe that Canopy’s focus on “premiumizing” its cannabis branded portfolio in Canada “is appropriate,” and they remain supportive of Canopy’s efforts to strengthen their emerging consumer packaged goods brand distribution.

Fitch said further negative rating actions could be taken if the company’s “premiumization” cultivation strategy fails, or if it pursues a repayment of the remaining 2023 notes that Fitch considers a distressed debt exchange, if liquidity appears constrained, such that a default is probable.

Canopy shares trade as WEED on the Toronto Stock Exchange and as CGC on the Nasdaq.

Matt Lamers can be reached at matt.lamers@mjbizdaily.com.