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Caution Is Required Ahead of Canopy Growth’s Earnings

Expectations are too high for CGC stock ahead of earnings

Canopy Growth (NYSE:CGC) has built up a lot of excitement ahead of earnings. The marijuana sector has been on fire to start 2019. With CGC stock’s strong performance, it has easily passed Tilray (NASDAQ:TLRY) to reclaim its place as North America’s most valuable marijuana company. While Tilray stock is up a modest 10% year-to-date, CGC stock has surged 70% since the start of 2019.

Marijuana stocks
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However, this is a good time to lock in some profits on CGC stock. Signs are pointing to the company missing expectations on its earnings report. The market is likely to sell off Canopy stock following that. If you want to be involved in CGC stock here, the smart play is to wait for the stock to shake out after earnings before taking a position.

Earnings: Don’t Expect Big Results

This earnings report is not likely to be a big event for CGC stock. That’s simply because legalization is too recent for sales to have really taken off yet. Aurora Cannabis (NYSE:ACB) pointed to this fact with their earnings conference call earlier this week. Aurora noted that it had sales of CAD $21.6 million in the recreational market.

Aurora Chief Corporate Officer Cam Battley noted that:

“Overall based on the statistics provided by Health Canada for the period October 17 to December 31, 2018, we achieved over 20% market share. Approximately one in five grams of product sold to Canadian consumers comes from one of the Aurora brands”.

We can figure from that statement that the overall recreational market for this past quarter was around CAD $110 million. Canopy produced just CAD $23 million in consumer revenues last quarter. Thus, the analyst expectations from Canopy of CAD $85 million for this quarter seem a bit ambitious. That would require revenues more than tripling over a three month span.

Yes, recreational is operating in Canada, in addition to Canopy’s other pre-existing markets. But given that the Canadian market is still so small, based on Aurora’s reported results, it seems doubtful that Canopy achieved enough incremental growth to hit the analyst consensus.

It’s possible that CGC still tops expectations as there are a lot of moving parts. The company is building out its retail operations, for example, which could provide a significant chunk of additional revenue. Overall, however, given the sobering numbers from Aurora earlier this week, don’t expect a big beat from Canopy either.

An Earnings Dip Could Be A Buying Opportunity

Let’s be clear, in the long run, this quarter’s earnings hardly matter for Canopy Growth. We’re talking about a company with a market cap of CAD $21 billion ($16 billion) here. CAD $85 million is a laughably small revenue figure compared to the market cap, so it hardly matters if the company beats or misses that figure by five or ten percent.

What does matter is the overall growth trajectory. How is the company doing in terms of market share? How are the retail operations going? Is the company developing strong brands and lasting relationships with its clients? That’s the stuff you need to be focused on.

It’s worth remembering that Aurora stock initially dropped on its somewhat underwhelming earnings report but reversed course and headed higher. Analysts looked past the numbers and took a look at the outlook for the rest of 2019 and beyond.

The same thing could happen with CGC stock on Friday assuming it does in fact miss earnings. Ultimately, a couple years from now, no one will care about today’s earnings results. The numbers are simply too small to matter compared to the market cap.

What does matter is if management can continue executing on its growth story. At the end of the day, all of these marijuana companies need revenues to go up many-fold to justify their current valuations. So, the main focus on your investment outlook for a stock like CGC should be whether they can deliver over time or not.

CGC Stock Verdict

I am not a fan of CGC stock heading into earnings. Shares rallied heavily on Wednesday, and are way up from recent levels. This seems like a good place to take some profits. I’d also note from a technical analysis standpoint that the stock is facing fairly heavy overhead resistance at the $50 level. CGC stock spent most of September and October trading around $50-$52 share.

After the big drop last fall, CGC stock bottomed in the $20’s. In January, it rallied sharply but once again the rally stopped dead in its tracks once it hit $50 level. This is clearly turning into a make or break level for the stock. That makes sense. Constellation (NYSE:STZ) invested in Canopy with the stock around $30. That effectively puts a floor on shares, since at $30, you can buy for the same price as the company’s major backer. Once it gets up to $50, people who bought at $30 can sell for 67% gains. Given this technical dynamic, it’d take a great earnings report or serious positive momentum within the marijuana sector to get CGC stock over $50 in the near term.

As such, the optimum trade for earnings to be on the sidelines heading into the report. If the company comes up short of estimates and the stock drops back toward $40, that’d be a nice place to look to buy the dip. If the stock does break out over $50 and keep going, that could set up a nice momentum trade as well. But until CGC stock breaks that level, the stock remains a risky play, particularly ahead of earnings.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

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