Canopy Growth Stock Has to Overcome an Important Obstacle

Given its broad reach and its war chest, CGC stock is the easiest pure play on weed. But is CGC stock price too high?

At least in the current, early stages of the legal marijuana sector, Canopy Growth (NYSE:CGC) is the clear leader. Canopy Growth stock has by far the highest market capitalization among marijuana stocks, and Canopy has the largest peak production capabilities.

marijuana cannabisAs a result, the CGC stock price is somewhat of a weather vane for investor sentiment towards the cannabis sector more broadly.

That’s good news, and bad news, for CGC stock. On the plus side, CGC is simple. The company’s reach is broad  and continues to grow. However the industry’s growth plays out, Canopy Growth is going to play a significant role in it and generate significant profits. If the marijuana sector exceeds investors’ expectations, the CGC stock price likely will do the same.

The flip side is that it’s unlikely that Canopy Growth stock will be the best marijuana stock over time. Smaller niche plays might have more room for growth and are more likely to become M&A targets. Canopy’s wide reach guarantees at least a few wins, but some of its myriad initiatives will fail to bear fruit (or, more accurately in this case, flowers).

Overall, the outlook of CGC stock is pretty simple. If an investor believes in cannabis, CGC stock remains the simplest play, as I’ve argued in the past. But with the CGC stock price still not too far from its highs, it’s worth remembering that an awful lot of belief, and potential success, looks priced into Canopy Growth stock.

Canopy Growth Expands Its Reach

The $4 billion-plus investment Canopy Growth received from Constellation Brands (NYSE:STZ,NYSE:STZ.B) gave the company an unparalleled war chest. Only Cronos Group (NASDAQ:CRON), which received $1.8 billion from tobacco giant Altria (NYSE:MO), comes close.

Canopy is putting that cash to work. It negotiated a complicated deal with Acreage Holdings (OTCMKTS:ACRGF) to enter the U.S. market, including a $300 million upfront payment. (An activist Acreage shareholder could scuttle that purchase, however.) CGC is adding production capability. Canopy brought a German cannabinoid compounder into the fold earlier this month. Its smaller deals include a buyout of a U.S. hemp manufacturer and a stake in a ‘”cannabis beauty brand.”

Those acquisitions add to the company’s already-strong portfolio. Canopy Growth sells marijuana under six different brands. Its existing production capabilities appear to exceed 500,000 kilograms annually. Canopy produces oil and softgels in addition to dried flower. The Constellation partnership should give the company an edge in cannabis-infused beverages and edibles.

Canopy already has a reach that far exceeds that of any other cannabis company. Aurora Cannabis (NYSE:ACB) is probably its closest rival in terms of breadth of geographic and market exposure. But even Aurora doesn’t reach Canopy’s levels, and ACB doesn’t have an extra few billion dollars on its balance sheet that it can use to take advantage of more opportunities along the way.

CGC or an ETF?

At this point in the market’s evolution, one key argument for Canopy Growth stock is that it can function like an ETF. The point of an ETF is to capitalize on a trend without making the effort or taking the risk that investing in single stocks requires. There are, by one count, over 400 marijuana stocks at the moment. As is usually the case with a “hot” trend, many of those stocks will decline or go bust. (Think, for instance, of the dot-com bubble, or more recently, cryptocurrency/blockchain plays.)

In fact, I’d rather own CGC stock than the largest marijuana ETF, the ETFMG Alternative Harvest ETF (NYSEARCA:MJ).   Two marijuana pharmaceutical plays, GW Pharmaceuticals (NASDAQ:GWPH) and Corbus Pharmaceuticals (NASDAQ:CRBP), together make up more than 12% of Canopy’s assets. And, again, Canopy’s reach means it should have at least some success, no matter how the marijuana industry develops.

If oversupply makes production less profitable, CGC’s distribution and retail operations should benefit. If consumption moves towards edibles and away from flowers, it should be well-positioned for that shift. That’s not the case for many smaller plays, including those that make up the MJ ETF.

The Risks Facing CGC Stock

There’s one obvious catch for Canopy Growth stock, however. Even if Canopy can capture marijuana growth in myriad ways, that growth needs to support the current CGC stock price. And I’ve become increasingly cautious about that recently.

At its December lows, CGC was available for less than the price that Constellation paid. (Constellation handed over roughly $35 per share, depending on how warrants Constellation received as part of the deal are valued). But now that CGC stock price has reached the mid-40s, that’s no longer the case. As the Acreage activist noted, CGC trades at a stunning 178 times its estimated 2020 EBITDA.

That multiple isn’t out of line for the sector, but that’s precisely the point. Current valuations in the industry, including that of Canopy Growth stock, suggest that massive industry growth is all but a foregone conclusion. And I’m skeptical about whether it will play out quite that way.

For instance, recreational sales in Canada already are starting to flatten out., so the explosive rallies of marijuana stocks are going to end. Marijuana prices have plunged in the few regulated U.S. markets. And legalization, given the size of the existing black market (and the relative ease of using it for most consumers), won’t necessarily lead to higher sales.

Those trends suggest that the initial optimism toward marijuana, and the enormous valuations assigned to marijuana stocks, may have gone a bit too far. That, in turn ,suggests that the CGC stock price may have done the same. For marijuana bulls, there’s no simpler play than CGC stock. But for CGC stock to rise further, those bulls must be right.

As of this writing, Vince Martin has no positions in any securities mentioned.

 


Article printed from InvestorPlace Media, https://investorplace.com/2019/05/case-for-against-canopy-growth-stock-quite-simple/.

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