Summer has not been kind to Canopy Growth (NYSE:CGC) stock. In fact, it goes back to the end of April, when shares of the Canadian cannabis giant were as high as $52.74. Since then, the shares are down 27.6% compared to a 15.4% decline in ETFMG Alternative Harvest ETF (NYSEArca:MJ), which lists CGC stock as the number five holding of the 38 pot stocks in the exchange-traded fund’s portfolio.
As there’s been a slew of bad news hitting the cannabis space, investors are having second thoughts on Canopy Growth stock. Less than a year after making a $5 billion strategic investment in CGC, Constellation Brands (NYSE:STZ) is taking a more active role in running the company. The beverage behemoth has forced out co-CEO/co-founder Bruce Linton, and put in its own people to run the show.
So with the decline, do investors have an opportunity to “buy the dip” or do recent developments indicate the stock has even more downside?
Let’s take a closer look and see what the verdict is for the CGC stock price.
With Linton out of the picture, Constellation is taking an active role in molding the future direction of Canopy Growth stock. So far, the company has not changed its operating strategy. According to a recent investor presentation, it is business-as-usual. The proposed acquisition of Acreage Holdings (OTCMKTS:ACRGF) is still on. With recent acquisitions of C3 and This Works, the company is making side bets on the global commercialization of CBD.
But despite chasing growth outside of North America, Canopy Growth remains levered toward U.S. federal legalization. This is in contrast to its peer Aurora Cannabis (NYSE:ACB). As I have discussed my recent InvestorPlace article, Aurora is widely placing bets, making that company less dependent on one market to move the needle. With this is mind, Canopy Growth has the edge when it comes to ruling the U.S. market. Legislation to relax federal marijuana laws is moving forward but it could be years before America is a fully open market.
In the meantime, investors should be concerned with Canopy stock’s current capitalization. With the company yet to turn a profit, the company remains dependent on share issuance to fund operations. The combination of shares, warrants, and convertible notes has left the company exposed to material dilution risks. This limits potential upside for holders of CGC stock.
There are two key components to the dilution risk. The first is the slug of warrants Constellation received with its strategic investment. According to Canopy’s most recent financials, Constellation holds two tranches of the warrants. The first tranche (called “New Warrants” in the filing) allows Constellation to buy 88.5 million shares at $50.40 a piece. Once these warrants are exercised, Constellation has the right to exercise the second tranche (or, “Final Warrants”), of 51.3 million shares at a price “equal to the 5-day volume weighted average price” prior to exercise. Adding 139.8 million shares to Canopy’s current ~345.8 million outstanding share count would be highly dilutive.
The second key dilution risk is the convertible debt Canopy issued in 2018. The $600 million of convertible notes matures in 2023, at which time they can be converted to common stock. The conversion price is $48.18 a share, meaning an additional 12.4 million shares could be issued. However, the dilution risk may be more severe. If shares of CGC stock do not trade above this exercise price in 2023, the company will have to raise more equity to pay off the debt. This scenario would be even more damaging to the CGC stock price. But despite both of these dilution risks, CGC stock continues to trade at an extremely high valuation.
The valuation of Canopy Growth stock remains high. Shares currently trade at an enterprise value-to-sales (EV/sales) ratio of 57.4. This is more expensive than ACB, which trades at an EV/sales ratio of 53.5. However, CGC stock sells at a lower valuation than Cronos Group (NASDAQ:CRON), which has an EV/sales ratio of 232.3. Tilray (NASDAQ:TLRY), another major competitor, also sells at a premium to CGC (EV/sales of 75.5).
This may make the CGC stock price look cheap, but the sector remains overvalued. With investor sentiment turning bearish, it may pay to wait a while before buying CGC stock. The sacking of Linton and the control grab by Constellation marks a new direction for the company. With U.S. legalization moving further out on the time horizon, it could be years before Canopy stock can live up to investor expectations.
CGC’s next earnings report is in mid-August. At that point, investors will get a clearer picture on the future of Canopy Growth stock. Investors could buy now, betting on earnings topping expectations. But this highly speculative position may not pay off. There may be a time down the road to buy CGC stock at bargain basement prices. But today is not that time. For now, avoid Canopy stock.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.