Coming down from a high can be a real drag. A high stock price, that is. Case in point, Canopy Growth (NYSE:CGC) which closed Friday at $27.46, coming down from a 52-week high of $56.90. There are industry concerns in terms of overcapacity of dry cannabis that has taken CGC stock lower. In addition, the company’s missing analyst estimates for first quarter of fiscal 2020 didn’t help in terms of stock momentum.
However, I am of the opinion that the downside might be overdone for Canopy Growth stock. I further believe that any level below $30 is attractive for gradual exposure to CGC. Before I talk about the positive triggers, I must mention that Canopy Growth is for long-term exposure.
The industry is still at an early growth stage and cash burn will continue. At the same time, CGC is well positioned to be among the leaders in the cannabis (recreational and medicinal) industry. It therefore makes sense to be invested in a potential value creator.
Spectrum Therapeutics will Drive Growth
Spectrum Therapeutics is a wholly owned subsidiary of Canopy Growth. The subsidiary is focused on research & development related to medical therapies. I believe that Spectrum is a key growth and margin expansion catalyst for Canopy Growth in the next 3-5 years.
To put things into perspective, Spectrum already has 1,000 patients participating in clinical trials. The company has 60 to 70 trials ongoing or completed.
The key point — Spectrum is targeting medical therapies in sleep aid, pain relief, anxiety relief and animal health products.
With a broad target market, export licenses in 10 countries and a deep pipeline of clinical trials, Spectrum is positioned to deliver value for CGC.
It is worth mentioning that CGC already has 111 patents with 270 patent applications. This underscores the point of intense R&D that is likely to translate into high-margin medicinal products.
Amidst the bull talk, it is important to mention that even when medicinal products are launched; it would need high marketing expenses. Margins can be suppressed and EBITDA growth will be very gradual.
Higher Margin Product Launch
In the first quarter results release, CGC has mentioned that the company will be launching value-add higher-margin products in October 2019, as the second phase of Canadian legalization comes in.
The high-margin products will potentially include beverages, athletic drinks and various wellness products. As an example, the acquisition of “This Works” will allow the company to launch range of natural skin care products. Similarly, cannabis-based beverages and vapes are in the pipeline.
CEO Mark Zekulin said on last month’s post-earnings conference call: “We believe that high quality cannabis beverages that offer sophisticated taste, better bioavailability and dose control, along with zero or low calories options and little or no drug interaction, will appeal to not only to current cannabis consumers, but also expand the cannabis consumer category to reach a larger portion of the population.”
Even with the launch of valued-added high-margin products, EBITDA margin expansion is unlikely on an immediate basis. But I do expect positive impact well into 2020 and 2021.
Observations on Cash Burn
For 1Q 2020, CGC reported negative operating cash flow of $158 million. This would imply negative annual cash flow of $630 million. Considering the company’s investment in R&D, sales and marketing, among others, I believe EBITDA margin will remain depressed. Along with this, operating cash flows might remain negative.
However, as of June 2019, CGC reported cash & equivalents of $1.8 billion. Considering the annual rate of cash burn, the current cash holding provides a buffer for three years. This is just an approximation, but seems to imply that Canopy Growth has enough cash to continue investing in research and marketing.
At the same time, the company is backed by Constellation Brands (NYSE:STZ), which I interpret as meaning that an extended period of cash burn is not a concern.
I do expect consolidation in the cannabis industry and Canopy Growth stock is likely to have a good acquisition appetite.
Final Thoughts on CGC Stock
CGC stock has trended lower in the last 12 months, understandably, considering that cash burn worries the markets. But the company’s revenue growth has remained stellar.
At the same time, Canopy Growth is among the best in the industry when it comes to investing in R&D. I expect the company to be among the leaders in medicinal cannabis.
The launch of high margin products next month needs to be closely monitored in terms of market response. It can be a potential game changer for Canopy Growth stock.
Overall, CGC stock is worth accumulating at current levels. While I don’t advise a big plunge in the stock or the cannabis industry, gradual accumulation makes sense.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.