Canopy Growth stock (NYSE:CGC) is experiencing growing pains. The Canadian-based cannabis giant, which reported tepid earnings last week, is balancing long-term strategy against short-term performance.
Last week’s earnings report dropped like a rotten egg. Gross recreational revenue fell from 71.6m CAD to 68.9m CAD quarter-over-quarter.
Gross margins have also fallen, as the company continues to invest heavily in their production operations.
With short-term sales declines, an astronomical valuation, and the primary catalyst having an uncertain timeline (U.S. Federal legalization of marijuana), is Canopy stock a buy today?
Read on to see if CGC stock has additional runway!
Weak Earnings Created a Dip in Canopy’s Stock Price
After the company’s earnings announcement on June 20, Canopy Growth stock saw an 8% decline (from $43.71 to $40.16). Since last week’s report, shares have traded sideways, with CGC stock finding support at ~$40/share.
Compare this with last fall, when Canada legalized recreational marijuana usage. The excitement from this announcement pushed CGC stock to its 52-week high of $59.25 per share on Oct. 16, 18.
Since then, the Canadian cannabis gold rush has failed to meet investor expectations. But the story with Canopy Growth stock and its peers is not Canada, but opportunities when the U.S. marijuana market fully opens up to legal operators.
America, Not Canada Is the Play In CGC Stock
Bank of America Merrill Lynch estimates the global cannabis market to be worth $166 billion, with the USA making up one-third (~$55 billion) of that amount.
While many states have taken the plunge and legalized recreational use, federal regulations make it difficult to build a scalable business. If and/or when Federal Laws against marijuana are repealed, whomever has first-mover advantage stands to become the American pot industry’s dominant player.
With their proposed deal to acquire Acreage Holdings (OTCQX:ACRGF) when the federal government repeals marijuana restrictions, Canopy has the strongest shot.
Add in a $5 billion strategic investment by Constellation Brands (NYSE:STZ), and it is clear that Canopy Growth stock is the “smart money” play.
But at the current valuation, is Canopy stock “smart” for your portfolio?
CGC Stock Trades At a Sky-High Valuation
Investors who bought into CGC stock years ago have seen tremendous appreciation. While they sacrificed value for growth, as a path to legalization became clearer shares rapidly went up in value.
But how about for investors entering the stock today? Is there any compelling thesis to justify the current valuation?
Trading at 87 times sales, Canopy Growth stock is richly valued compared to many of its peers:
- Aphria Inc. (NYSE:APHA): 32.88
- Aurora Cannabis (NYSE:ACB): 55.11
- Hexo Corp. (NYSEAMERICA:HEXO): 80.47
- Tilray, Inc. (NASDAQ:TLRY): 207.88
- Cronos Group (NASDAQ:CRON): 241.42
While Canopy has many advantages over its smaller peers, I believe this “scale premium” is highly inflated. If and when marijuana is fully legalized in America, Canopy Growth will have a size advantage. But in that scenario, incumbent consumer products companies (the tobacco and alcohol industries) could easily put money to work and gain material market share.
With all of this uncertainty, is it worthwhile to pay a sky-high valuation for Canopy Growth?
Bottom Line: Is CGC Stock a Buy Today?
As a business, Canopy Growth has strong potential to become a major U.S. Cannabis producer. As a stock, CGC remains overvalued, with investor expectations pushing its valuation to sky-high levels.
Initial “smart money” may place their bets on Canopy Growth stock, but it could be years before large institutional investors pounce into the cannabis space.
With the stock continuing to trade a high valuation, they may be waiting for a better entry point. Continued weakness in the cannabis space (delays in relaxed US restrictions, weak Canadian sales) could push all of the major cannabis names back to more reasonable valuations.
Why pay more today when you can join the “smart money ” when the time is right?
Given the choice of buying Canopy Growth stock or waiting things out, I choose the latter. Much of the upside in CGC stock is already factored into the stock price. Add in a lack of immediate catalysts, and it is difficult to create a logical investing thesis that is bullish on CGC stock.
It is tough to predict the unpredictable. It could be only a few years until federal legalization occurs, or it could be another decade. In the short-term, Canopy stock will likely see more dips and less rips.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
