Canopy Growth Stock Likely Gets Worse Before it Gets Better, But That’s Okay

CGC stock has been punished along with its peers, but it's best of breed in the cannabis space

In the world of cannabis equities, nothing seems to be working these days, a sentiment that extends to Canopy Growth (NYSE:CGC) stock. Shares of the Canadian pot producer are down nearly 19% year-to-date, but the bad news doesn’t end there. Far from. As of Oct. 1, CGC stock sat more than 63% below its 52-week high.

CGC Stock May See More Downside but It's a Long-term Winner
Source: Jarretera / Shutterstock.com

Said another way, when applying the strict definition of a bear market being a 20% decline from the previous high, Canopy Growth stock is in a bear market three times over. When running through data like that, particularly in an industry where all the constituents have been drubbed, getting excited about an individual name can be difficult.

On the other hand, contrarian investors may use an opportunity like this current marijuana meltdown to find the strongest names, or the babies being thrown out with the bathwater. In an industry full of companies losing money, struggling to generate cash and without much access to traditional financing, at least not in the U.S., Canopy Growth stock is attractive for the sheer fact that the company has $2.3 billion in cash. Not surprisingly, some analysts prize that characteristic.

“Canopy is well positioned in the sector, particularly with US$2.3 billion in cash in an industry recently facing growing difficulty raising capital,” wrote Piper Jaffray analyst Michael Lavrery in a recent note.

Punished and Now Inexpensive

One of the primary issues vexing cannabis investors is that amid the recent bear market for these equities, many have been punished, but not many are inexpensive. Yes, it’s accurate to say cannabis stocks are growth, not value fare, so finding value in the traditional sense within this group may at times prove difficult.

At just over 357x (yeah, that’s right) forward earnings, Canopy Growth stock is by no means cheap, but a case can be made the shares have been punished for margin contraction. Thing is, the company’s gross margins recently contracted due to Canopy building new plants that have not yet started production. Strip out those expenses and the company’s margins are much more attractive.

“However, the narrower margins were largely due to costs associated with facilities that have yet to begun production and some product mix shift,” said Morningstar in a recent note. “Excluding these, gross margins remained healthy at 32%. Canopy expects margin to return to the 40% range by the end of fiscal 2020.”

The research firm added that it’s not concerned by the tighter margins, that Canopy’s expenses as a percentage of sales, and most importantly, the company will eventually achieve profitability.

What Canopy needs to do is establish some presence in the U.S. recreational market because not only does research confirm that’s where the growth is, but some academics believe high taxes in some states, such as California and Washington, are not a deterrent to legitimate cannabis purchases and consumption.

Research by UCLA Assistant Professor of Marketing Anderson’s Brett Hollenbeck and Yale School of Management Associate Professor Kosuke Uetake “implies that other states could significantly increase pot revenues by simply following Washington’s lead to a 37 percent tax rate,” according to the Anderson School of Business.

“The [academics] calculated California’s potential revenue using a simple extrapolation of legal marijuana sales per resident. The state’s annual pot tax collections, they estimate, would shoot to about $1.68 billion from $813 million if it raised the tax rate to 37 percent from its current 15 percent (the figures imply some decline in legal sales). Reaching those numbers would require California to enforce rules against the black market.”

Bottom Line on Canopy Growth Stock

Canopy Growth stock is buoyed by one of the industry’s tidiest balance sheets, but that doesn’t mean investors need to jump into the stock just yet. While it may be one of the group’s strong constituents, CGC stock has clearly shown it’s not immune to the cannabis industry’s growing pains.

For the patient investor, there’s a lot to like here. After all, Morningstar has a fair value estimate of $54 on Canopy Growth stock, more than double where the shares currently reside.

Todd Shriber does not own any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2019/10/canopy-growth-stock-could-see-more-downside-but-its-a-long-term-winner/.

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