Down 25% in a Month, CGC Stock Could Fall Further

Weak growth and dilution risk call into question Canopy Growth's valuation

Canopy Growth (NYSE:CGC) stock has taken a pounding. Shares are down nearly 25% in the past month, from $35.40 per share to $26.57 per share. The investor exodus from marijuana stocks has been brutal.

It's Just a Matter of Time Before Canopy Growth's Woes Hit Constellation
Source: Shutterstock

With excess supply outgunning demand, it’s no wonder the bull case for pot stocks is tough to justify. But can investors expect a rebound in Canopy Growth stock? Let’s take a closer look at the future of CGC shares.

Recent Performance of CGC Stock

CGC released earnings on Aug. 14. For the quarter ending June 30, net revenue was C$90.5 million, down from C$94.1 million in the prior quarter. Overestimating demand for CBD oils and capsules, Canopy lost out while its peers such as Aurora Cannabis (NYSE:ACB) continued to grow revenue. As a result, CGC saw operating losses of C$123.1 million for the quarter.

Despite oversupply in the market, CGC and the other Canadian cannabis names continue to ramp up production. Canopy harvested about 41,000 kg during the quarter. But sales were only 10,549 kg or kg equivalents. Like Aurora Cannabis, Canopy has gotten ahead of itself in its fast drive to scale operations.

But is short-term thinking not the way to go with cannabis stocks? As InvestorPlace contributor Luke Lango wrote on Aug. 19, “there is still visibility for Canopy to one day be a $50 to 100 billion company.” Investors buying in now may see tremendous gains over a long time frame.

What about investors with a shorter time horizon? Is upside priced in, or can investors get a discount? Let’s take a look at the valuation of Canopy Growth stock.

Valuation: Canopy Growth Stock Still Frothy

Canopy Growth stock currently trades at a Enterprise Value/Sales (EV/Sales) ratio of 32.2. This is a discount to the current EV/Sales valuation of Aurora Cannabis. ACB trades at an EV/Sales ratio of 48.2 In terms of other peers in the “cannabisphere,” Cronos Group (NASDAQ:CRON) continues to trade at a high valuation (EV/Sales of 150.7). Tilray (NASDAQ:TLRY) trades at a discount to CGC, with an EV/Sales ratio of 31.4.

With the recent beat-down of Canopy Growth stock, shares are now a bargain compared to Aurora Cannabis. But, as I wrote earlier this month, Aurora Cannabis seems to have a better growth playbook. By focusing on the medical marijuana space, Aurora is the safer cannabis stock play. But an overlooked risk factor in both cannabis stocks is dilution. The use of share issuance and warrants to finance unprofitable operations minimizes upside for investors.

CGC Stock Dilution Risks Continue

The company’s partnership with Constellation Brands (NYSE:STZ) was initially seen as a boost for CGC stock. But as the partnership progresses, it is clear the deal is terrible for shareholders. Constellation’s $5 billion dollar investment included the issuance of warrants. These warrants came with certain covenants to protect Constellation from dilution. CGC’s proposed buyout of Acreage Holdings (OTCMKTS:ACRGF) triggered a renegotiation of warrants. Due to this revision, CGC was forced to reprice the Tranche B warrants, resulting in a C$1.2 billion non-cash charge.

As I wrote on July 29, dilution continues to be a problem for Canopy Growth stock. This dilution risks goes beyond the Constellation partnership. $600 million in convertible debt comes due in 2023. The conversion price is set at $48.18 a share. If CGC stock continues to languish under this strike price, the company will likely need to raise more capital once the notes mature.

Of course, Canopy Growth could be profitable by 2023, and would have an easier time refinancing the debt. But investors should take the dilution risk seriously. With much of Canopy’s potential priced into shares, dilutive capital raises could cap the stock’s upside potential.

Bottom Line: The Canopy Sell-Off Isn’t Over

Canopy stock is down more than 50% from its 52-week high. But shares could go lower. With Canadian market growth nonexistent, Canopy needs U.S. legalization fast in order to move the needle. With federal legalization still years off, CGC will likely continue to burn cash as it scales up operations. The partnership with Constellation Brands provides plenty of capital to keep the lights on. But the terms of the partnership give Constellation an easy way to takeover the company at a discount.

So what’s the call on CGC stock? Investors should continue to wait on the sidelines until the situation improves. If Canopy Growth stock falls another 50% (or more), there could be a buying opportunity. I do not deny that we are the early stages of the marijuana legalization story. But investors need to wait until hype has dissipated to consider stocks such as CGC.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2019/08/cgc-stock-could-fall-further/.

©2019 InvestorPlace Media, LLC