Fitch Ratings has downgraded the ratings for
The ratings downgrade reflects Canopy's significant market share losses in the Canadian market, given execution missteps and operating challenges with pivoting its cultivation strategy, which has resulted in weak operating results with an uncertain path to profitability and reduced liquidity. As a result, it is highly doubtful that Canopy can improve EBITDA trends to reach operating cash flow breakeven in fiscal 2025(March 31) as Fitch previously expected, and creates greater uncertainty around capital structure sustainability.
Fitch could take further negative rating actions if Canopy pursues a repayment/refinancing of the
Key Rating Drivers
Canadian Market Share Losses: 2021 Canadian cannabis retail sales grew by around 50% to
Marketplace dynamics are challenging, including evolving consumer preferences and the competitive environment with significant pricing compression, particularly in the value segment that has caused material profitability pressures within the sector. Consequently, Canopy has recognized significant asset impairments. The industry has already experienced one cycle of production overexpansion and consolidation, as the sector matured following legalization in 2018.
In response to the operating challenges, Canopy announced restructuring actions that it expects to generate
Consistent Cultivation Strategy Key: A key strategy to improve profitability, is a change in Canopy's genetics and cultivation strategy to higher quality cannabis with the right attributes (i.e. higher THC, single-strain, good terpenes) for the premium and mainstream flower, pre-rolls, edible and vape markets, while using the value segment as an outlet strategy. Canopy has several brands to leverage this strategy including DOJA, 7ACRES, Tweed and
Fitch views Canopy's premiumization strategy and increased distribution for BioSteel as coherent. Nevertheless, there are still significant execution risks. The company believes it has made material progress with its strategy given growth and positive mix shift during 4Q22, and expects to have 100% of internally sourced cannabis available for 2H23, supplemented by partnerships with craft growers of selective strains to service the marketplace. However, to increase market share and sustain top-line gains, Canopy will also need to drive retail velocities focused on budtender education and point-of-sale merchandising. BioSteel is also expected to materially increase distribution to more than 50,000 points by end of fiscal 2023 as the company invests in the brand.
Assessing Repayment Options: Canopy is assessing various options for the repayment of the upcoming
Fitch expects the company could seek options to preserve liquidity given ongoing high cash burn. As such, the company could pursue a notes repayment option that Fitch views as a distressed debt exchange.
Parent-Subsidiary Linkage: Canopy's ratings receive a one-notch uplift from its SCP due to the stake
Fitch believes a medium strategic linkage exists between the two companies given Canopy's portfolio adjacencies that could support moderate growth potential and reasonable financial value to Constellation's future group profile following
Constellation holds four of seven board seats at Canopy, and several past senior Constellation executives hold key positions at Canopy. Fitch could revisit our views with the strategic linkage based on lack of execution with its premiumization strategy and/or lack of material US cannabis reform.
In addition, it is uncertain whether Canopy could exercise rights to full control prior to
Derivation Summary
Canopy's 'CCC' rating reflects the significant market share losses in the Canadian market given execution missteps and challenges with pivoting its cultivation strategy, which has resulted in weak operating results with an uncertain path to profitability and reduced liquidity. As a result, Canopy has pursued actions to right-size cost structure, improve efficiencies, and is in the midst of pivoting its genetics and cultivation strategy away from value to the premium and mainstream segments that has been slower than expected.
The rating also considers Canopy's position as a scaled Canadian licensed producer with an extensive cannabis portfolio in the medical and recreational market with leading premium market shares, significant licensed cultivation and production operations, portfolio of related CPG brands, and a pathway to a potentially much larger
The company has approximately
Canopy is rated lower than
Legends' rating reflects the ongoing recovery of the company's financial metrics following pandemic-related disruptions to its business model, which drove EBITDA negative in 2020, with Fitch expecting leverage to return to the low-7x in 2022 and FCF approaching neutral in 2023.
KDC's 'B-' Issuer Default Rating (IDR) reflects KDC's status as a global leader in custom formulation, packaging and manufacturing solutions for beauty, personal care and home care brands, supported by a diverse product portfolio and customer base, ranging from blue-chip names to 'indie' brands, with whom the company typically maintains long-term relationships.
Fitch expects KDC's broadening platform, including the recent
Key Assumptions
Fitch's Key Assumptions Within the Rating Case for the Issuer:
Revenue increase of approximately 8% in fiscal 2023 to mid-CAD500 million range supported by successful execution on the genetics cultivation strategy reflecting increased premium and mainstream market shares, increased distribution of BioSteel and volume growth in Storz and Bickel products. Growth in fiscal 2024 to around
EBITDA deficit in the mid
Capital spending of around
FCF deficit of close to
Bolt-on M/A transaction structured similar to Jetty Extracts targeting the
Successful repayment/refinancing of convertible notes maturity;
Forecast does not assume any changes in US Cannabis laws regarding federal THC permissibility or federal banking reforms.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Good execution with on-going strategic initiatives that results in greater clarity around a pathway to profitability that generates positive EBITDA, significant reduction in operating deficits and improved liquidity to fund ongoing operations and necessary investments over the next 24 to 36 months;
Positive changes in the regulatory environment.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Canopy enters into an agreement with convertible bondholders that could be classified as a Distress Debt Exchange Rating per Fitch's Criteria;
Lack of execution on premiumization strategy and profitability improvement that is materially lower than expectations of Canopy reaching EBITDA positive in fiscal 2024 excluding investments in BioSteel and
A material adverse change in the strategic relationship with Constellation or Fitch's assessment that the moderate strategic linkage between Constellation and Canopy has weakened.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
Liquidity and Debt Structure
High Cash Burn, Weakening Liquidity: The ongoing cash burn and M&A strategy combined with current market conditions have eroded Canopy's liquidity position and could hamper its ability to access additional capital. Cash, cash equivalents and short-term investments totalled
Canopy's liquidity was supplemented in
Recovery Considerations
For issuers with IDRs at 'B+' and below, Fitch performs a recovery analysis for each class of obligations. Issue ratings are derived from the IDR and the relevant Recovery Rating (RR) and notching based on expected recoveries in a distressed scenario. Fitch takes the higher of liquidation value or enterprise value (EV, based on 6.0x multiple applied to the stressed EBITDA) to determine the waterfall recoveries.
The 6.0x for Canopy considers historical bankruptcy exit multiples for CPG companies ranging from 4.0x to 10.0x, with a median reorganization multiple of 6.3x. The 6.0x for Canopy considers Canopy's brands and Constellation's current operational and financial support. Fitch also considers the value accorded to the agreements to purchase interests for Wana, Jetty Extracts,
For Canopy, the recovery of the
In deriving a liquidation value of the assets for around
Fitch assumes borrowings under the
Issuer Profile
Canopy is a leading global diversified cannabis and hemp company based in
Summary of Financial Adjustments
Fair value of debt adjusted to reflect debt amount payable on maturity, stock-based compensation, transactions expenses, impairments and restructuring costs.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
RATING ACTIONS
Entity / Debt
Rating
Recovery
Prior
11065220
LT IDR
CCC
Downgrade
B-
senior secured
LT
B
Downgrade
RR1
BB-
LT IDR
CCC
Downgrade
B-
senior secured
LT
B
Downgrade
RR1
BB-
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