I had a front-row seat for the dot-com bubble, which makes me skeptical toward stocks in “hot” sectors. So I’ll admit to an intrinsic bias against the recent marijuana craze and stocks like Canopy Growth (NYSE:CGC). Canopy Growth stock has an intriguing story, admittedly. But valuation concerns also surround CGC stock and the sector as a whole.
Bulls may retort that Canopy Growth stock is the best-in-breed among marijuana companies. That’s probably true. They might add that marijuana sales are likely to grow for decades to come. That’s likely true as well.
Maybe they would point to the $4 billion investment by Constellation Brands (NYSE:STZ,STZ.B) in CGC stock. They’d be right again as I wrote last month, that deal quite literally transformed the publicly traded marijuana sector.
But I’d point out that CGC stock now has risen nearly 500% over the past year. It trades at something like 150x revenue. And for two key reasons, even if Canopy Growth stock is the best stock in the sector, that doesn’t mean CGC stock is a buy.
Enthusiasm Toward Marijuana and CGC Stock
Investors have rushed into marijuana stocks. Tilray (NASDAQ:TLRY) has seen unbelievably volatile trading. Aurora Cannabis (OTCMKTS:ACBFF) has more than doubled since mid-August.
Canopy Growth stock has soared as well. CGC stock has doubled since the Constellation investment last month. But the trading here still feels much more normalized, particularly relative to the jaw-dropping volatility (and option premiums) in TLRY.
CGC stock actually had traded sideways for most of 2018. Constellation’s investment came at a price that was 51% above the Canopy Growth stock price on the Toronto Stock Exchange.
That vote of confidence alone should have sent the stock soaring as it did. But that alone doesn’t mean that CGC stock is worth $50 per share.
The Constellation Investment
The Constellation Brands investment no doubt legitimizes CGC stock. And it gives the company a treasure trove of capital that should provide a huge advantage over competitors.
But again, Canopy Growth has doubled since the investment. On the Toronto exchange (under ticker WEED), it now trades 32% above the price Constellation was willing to pay.
WEED stock in fact trades 28% above the price of warrants granted to Constellation, exercisable over the next three years. All told, Constellation can acquire nearly 140 million additional shares: 88.5 million at C$50.40, and 51.3 million at the weighted average price.
Constellation now is well in the money (by almost $1 billion) on those warrants. But they represent dilution for Canopy Growth shareholders, even if their exercise will bring in more cash to fund Canopy Growth’s efforts.
But more broadly, as good as the Constellation deal was, investors who buy CGC stock now are paying a 32% premium to what Constellation did. That alone suggests that either CGC’s run should slow down soon or that Canopy Growth management is vastly underestimating the potential of their own company.
Canopy Growth Stock and the Industry
Meanwhile, the fact that Canopy Growth is an industry leaders doesn’t guarantee upside from here or even success for the business. Many of the dot-com leaders eventually fell by the wayside; Alphabet (NASDAQ:GOOGL,GOOG) wasn’t even eighteen months old at the peak of the dot-com bubble.
Recreational marijuana in Canada is going to be a huge market. But it will take time to develop and the question has to be what Canopy Growth looks like a decade now.
After all, investors currently are paying 100x+ sales for precisely that potential. But will what is essentially an agricultural producer be able to maintain premium margins? Is the retail opportunity with the acquisition of Hiku that huge given that Hiku sold itself for barely $200 million?
There are a lot of questions left to be answered and a lot left to play out. And a dollar in 2028 isn’t worth a dollar in 2018 or close. Yes, marijuana is going to be a big business. The internet turned out to be a massive business, too.
But even Cisco Systems (NASDAQ:CSCO), which was a hugely successful provider of the infrastructure needed to meet internet demand, trades below its dot-com bubble peak valuation. I wouldn’t be terribly surprised if Canopy Growth turns out to be equally successful and meets the same fate.
As of this writing, Vince Martin has no positions in any securities mentioned.
