The news just keeps getting worse for Canopy Growth (NYSE:CGC). The Canopy Growth stock price has fallen by over one-third just since the beginning of May. And the issues go beyond CGC stock price.
Fiscal Q4 earnings in June disappointed, with investors concerned about the company’s profit margins. The company is fighting with majority shareholder Constellation Brands (NYSE:STZ,NYSE:STZ.B), who evidently forced out Canopy’s former co-CEO. Revenue in the Canadian market has been slower than expected. As a result, marijuana stocks across the board — not just CGC — have pulled back.
As disappointing as the news has been of late, however, there’s at least some reason to see a bottom in the Canopy Growth stock price. At $32, investors now can buy CGC stock at roughly the same effective price paid by Constellation Brands. Fiscal first quarter earnings due next week give the company a chance to re-shape its narrative. And broad markets, at least for now, have settled, which might create some breathing room for higher-risk cannabis plays.
But for that bottom to arrive, Canopy Growth needs to post an earnings report next week that at least looks solid. And investors might do well to see that report come in — and play the ensuing bounce — rather than betting on a company that, right now, doesn’t look like it’s headed in the right direction.
Why Earnings Matter for the Canopy Growth Stock Price
The trajectory of CGC stock alone shows why next week’s earnings are important. The stock has been falling almost without interruption for three months. Even after those declines, it’s not as if CGC is cheap: the stock, even backing out its net cash, still trades at something like 10x FY20 revenue.
The company needs a catalyst. Next week’s earnings, due on Wednesday afternoon, seem like the best potential catalyst Canopy Growth has. Recreational marijuana legalization worldwide appears unlikely to expand significantly in the near-term. Canada can do better — and is starting to show improved growth of late — but simply isn’t a big enough market.
In short, Canopy needs to convince investors that its enormous cash haul from the Constellation Brands investment will make it not a leader, but the leader in the space. That task gets more urgent after a blowout quarter from smaller rival Aphria (NYSE:APHA). Aphria posted better-than-expected revenue growth and guided for nicely positive Adjusted EBITDA in its fiscal 2020.
In a sense, Aphria set the bar. If Canopy — with US$4 billion-plus in the coffers thanks to Constellation — can’t do what Aphria can, investors are going to ask just why CGC gets a premium to most other marijuana stocks. Is there a management problem here, highlighted by the clash between Canopy’s executives and those of Constellation Brands? Is execution lacking?
A disappointing quarter from Canopy Growth raises those types of questions. The company needs at least a decent quarter that shows it is on track for bigger and better things going forward.
CGC Stock Is Cheap Enough, If …
Again, Canopy Growth stock isn’t cheap in terms of traditional metrics. But it might be cheap enough that it can rally off an earnings report that simply calms investor fears to some extent.
The case for Canopy Growth stock being reasonably cheap here is that $32 is about what Constellation agreed to pay in August. As I’ve written before, Constellation paid over US$37 for its shares — but it also received warrants for another 139 million shares. Depending on how an investor values those warrants (which depends on the assumed discount rates and volatility for the stock), I’ve estimated Constellation’s effective price probably was in the $30 range.
So there are two very different narratives that can emerge from Canopy Growth earnings. A solid quarter creates a nice — and simple — bull case. Canopy Growth is back on track. It’s growing at a solid clip: analysts expect over 300% year-over-year revenue growth in Q1. And investors can buy in at roughly the same price Constellation paid.
Any disappointment, however, upends that case. Investors will worry that Canopy Growth is losing share to the likes of Aphria, or other peers like Cronos (NASDAQ:CRON) or Aurora Cannabis (NYSE:ACB). Constellation’s investment will look foolish. The fact that STZ stock is down since its investment will be cited as evidence the beverage company overpaid. Investors may well flee, even with the pullback since May.
A Big Quarter for CGC
This is a huge quarter for Canopy Growth stock. Support for CGC looms in the mid-20s. Bust through that with a post-earnings drop, and the declines can be steep, and painful.
Right now, the options market seem to agree. That market is pricing in a 10%+ move in CGC shares between now and next Friday. It’s possible that may even be conservative. Canopy Growth really needs a good quarter to change the narrative. If it doesn’t deliver, at 10x revenue, more downside could follow.
As of this writing, Vince Martin has no positions in any securities mentioned.