Black Market Weed Hurts Struggling Canopy Growth Stock

New statistics show legal marijuana production faces a stiff challenge

Surely the worst must be almost over, right? Every time it seems like marijuana stocks must be reaching a bottom, they find some new reason to hit even lower lows. Canopy Growth (NYSE:CGC) stock has not bucked the trend on that front.

Load up on CGC Stock Before the Disappointment Starts to Fade
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Recently, regulatory concerns and questionable management decisions across various marijuana companies have shaken investors’ confidence. Besides those issues, the lingering oversupply of legal marijuana in Canada continues to weigh heavily on the sector.

It is becoming more obvious that the black market remains a huge competitive problem. CBC recently reported that according to Statistics Canada, a sizable majority of Canadian pot consumers admit to purchasing illicit marijuana at least occasionally. And, they add, it’s even easy to buy black market marijuana online.

Analysts blame the high cost of legal weed. As long as the black market is cheaper, many people will go there. Making legal weed more competitive would either hit tax revenues or profit margins for companies like Canopy even more. Add it all up and it’s easy to see why investors are nervous about investing in things such as CGC stock.

Canopy Growth Stock Could Still Get Cheaper

Based on its performance recently, you could be forgiven for thinking that CGC stock is already cheap. When shares of something plunge from $50 to $20 in just six months, it seems like a huge bargain. There’s more to the story, though.

As you know, the whole marijuana sector has gotten absolutely shellacked in 2019. Thus, Canopy’s 60% decline isn’t that shocking. In fact, CGC stock has held up better than some of its peers. Furthermore, on a price-to-sales basis, Canopy is still the second-most expensive of the major players.

Only Cronos (NASDAQ:CRON), at nearly 40 times enterprise value to sales, is more expensive. But Canopy comes in at second-most expensive, as it is still at more than 20x. Rivals like Tilray (NASDAQ:TLRY), Aurora (NYSE:ACB) and Aphria (NYSE:APHA) are all closer to 15x. This suggests that CGC stock is still overvalued by at least 25% compared to other leading marijuana companies.

In the past, you could argue that Canopy deserved a huge market premium thanks to its big backer Constellation Brands (NYSE:STZ). But now that the Canopy/Constellation relationship has turned into a bust, it’s less clear how much value that major player endorsement still carries. Put another way, it’s no surprise that Cronos — with Altria (NYSE:MO) still on board — is now the clear market favorite in terms of valuation. CGC stock, on the other hand, could linger down here or even decline further unless marijuana as a whole really turns things around.

The Lawsuit: A Distraction, Not a Dealbreaker

One thing CGC stock owners don’t need to worry about is the recent lawsuit with Go Farm Hemp. Recently, according to a Hemp industry publication, Go Farm Hemp and Canopy both filed lawsuits against each other. Go Farm Hemp, a Nevada company, had a contract to farm hemp for Canopy in four U.S. states.

Go Farm Hemp filed its lawsuit against Canopy because Canopy didn’t pay part of its contract obligation to the company. Canopy, in turn, claims Go Farm Hemp failed to meet its required duties, produced a bad crop and wasted valuable hemp seeds. Canopy alleges that just a quarter of the production it paid Go Farm Hemp for actually produced a viable harvest. Adding to that, Canopy suggested that Go Farm Hemp didn’t know what it was doing, and deceived Canopy about the state of operations.

Given all the recent strife in the marijuana industry, you can’t blame investors for worrying about the potential impact on CGC stock. Keep a few things in mind, however. This is small potatoes. We’re talking a few million dollars and around a thousand acres of hemp production. In the (seemingly unlikely) event that Canopy faces a total defeat in court, it’s unlikely to hit CGC stock badly. With all the regulatory concerns around companies like CannTrust (NYSE:CTST)  and Hexo (NYSE:HEXO), it’s worth paying close attention to potential legal matters. But for CGC stock, the Go Farm Hemp situation won’t be a gamechanger.

My CGC Stock Verdict

While Canopy Growth stock owners don’t need to worry too much about that particular lawsuit, there’s plenty of other reasons for caution. The marijuana sector is in a major bust and it’s increasingly unclear how things will turn around.

Sure, edibles are coming soon in Canada, and more states are likely to legalize in the United States. Some international markets such as Mexico may come online as well. It’s not clear that any of this will be enough to overcome the elephant in the room: illicit production. As long as illegal weed is cheap and readily accessible, many customers will stick with that. And to get legal pot competitive, profit margins — which are already low — may have to drop further for the embattled producers. Against this backdrop, there’s no rush to buy CGC stock now, as peak tax-loss selling season kicks off.

At the time of this writing, Ian Bezek owned MO stock. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2019/10/black-market-weed-hurts-struggling-canopy-growth-stock/.

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