It’s been a rough 2019 for Canopy Growth (NYSE:CGC) stock. But the launch of the company’s “Cannabis 2.0” products next month could change that. Canopy and the pot space at-large could rebound if sales of beverages, edibles, and vapes live up to expectations.
But is this enough to move the needle for Canopy Growth stock? Even after a nearly 65% decline from its 52-week high, shares trade at a high valuation. Strategic partner Constellation Brands’ (NYSE:STZ) multi-billion dollar investment provided a cash cushion. However, as the company burns through cash, Canopy could eventually need additional capital infusions.
The pot space is betting big on “Cannabis 2.0”. Does this mean its time to buy ahead of launch? Don’t bet the ranch. While the shellacked share prices of pot stocks could rebound, all bets are off regarding upside.
But before we get to what will be, let’s review what was.
No Escaping a Terrible Quarter
Shares of Canopy Growth dropped to a two-year low yesterday after the company reported a weaker-than-expected $374.6 million net loss in its fiscal second quarter. It seems consumers lost interest in cannabis in the period, leading CGC to report $47.9 million in charges, including a $15.9 million inventory write-down.
To be sure, net revenue in the quarter tripled YoY to $76.6 million, compared with $23.3 million in the same quarter last year, but it was off from Q1’s $90.5 million.
What happened? Acting CEO Mark Zekulin blamed Ontario’s slow intro of pot retail stores as the biggest contributor to the miss. The province is the country’s biggest market , so that’s gotta hurt. He’s been quite vocal with authorities about green lighting more legal locations, but it seems to be falling on deaf ears — “Eh?”.
“Why it’s not just happening right away, I do not know,” Zekulin told BNN Bloomberg.
He isn’t expected to be “acting” much longer, as Canopy is reported to be zoning in on a permanent replacement for ousted co-founder and former CEO Bruce Linton.
Now, as I was saying … let’s take a closer look at CGC stock, and see why Cannabis 2.0 may not be enough to save the stock.
Cannabis 2.0: Reality vs. Hype for CGC Stock
Canada legalized recreational marijuana sales last year. The “2.0” of legalization came just last month, with the regulatory green light for CBD- and THC-infused drinks, edibles and non-flower products.
With Canopy’s launch of Cannabis 2.0 products coming on schedule for early December, we are getting a clearer picture of the new product launches. A few weeks ago, Barron’s took a look Canopy’s upcoming products. The company is launching 13 cannabis-infused drinks, a line of cannabis-infused chocolate, as well as vape products.
Is there demand for these products? Some 60% of cannabis users, and 80% of non-users want to try out infused beverages. With the drinks offering a low-THC buzz, they could be an alternative to alcoholic beverages like beer and wine.
Cowen analyst Vivien Azer is bullish about Cannabis 2.0’s impact on the industry. She projects these products could produce $2.3 billion CAD ($1.7 billion) in annualized sales by next year. But will this translate into revenue growth for Canopy? The company faces heavy competition in the beverage, edibles, and vapes space. Competitors like Hexo (NYSE:HEXO) have beverage launches of their own. Meanwhile, in its earnings report, the company said it used $404.7 million in cash, mostly for its operations, along with the construction of its manufacturing and beverage production facilities.
While beverages are a big part of the Canopy Growth stock story, the company is pursuing other growth opportunities. Recently, Canopy announced a partnership deal with Drake. But this celebrity “cannabis wellness” venture may not be a slam dunk. Canopy’s past celebrity partnerships have failed to pay off. These sorts of deals are good PR, but probably won’t move the needle.
Regulatory red tape remains a big headwind. A lack of retail locations makes it tough for companies like Canopy to unload swelling inventories. There’s a lot at play for the future of CGC stock, and not all of it hinges on “Cannabis 2.0”.
With these risks and opportunities, is Canopy Growth stock priced for a contrarian bet? Let’s look at valuation, and see if today’s price presents a strong entry point.
Canopy Growth Stock Richly Priced Relative to Peers
Using the enterprise value/sales (EV/Sales) ratio, CGC stock remains more expensive than most of its peers. Canopy trades at an EV/Sales (trailing 12 months) of 26.5x. Aurora Cannabis (NYSE:ACB) trades at trailing 12 month (TTM) EV/Sales ratio of 20.6x. Aphria (NYSE:APHA), Tilray (NASDAQ:TLRY), and Hexo all trade at lower TTM EV/Sales ratios than Canopy. Only Altria (NYSE:MO) backed Cronos Group (NASDAQ:CRON) trades at a higher valuation (TTM EV/Sales of 37.6).
But Canopy’s premium to ACB, APHA, TLRY, and HEXO could be justified. Like Cronos, Canopy is backed by a deep-pocketed partner. This provides the cash necessary to sustain operations as it scales to profitability.
As seen in my recent Cronos analysis, strategic partners can be a doubled-edged sword. With Cronos, Altria has incentive to drive the company’s share price lower, allowing it to take it over on the cheap. The same situation could occur with Canopy Growth stock. If shares fall further, Constellation can step in and acquire a larger share of the company at lower prices.
Constellation also has the opportunity to capture much of Canopy’s potential upside. The beverage giant holds multiple tranches of warrants. The first tranche allows them to buy 88.5 million shares at $50.40 CAD a share. The second and third tranches allow them to buy 51.3 million additional shares at higher prices. With declines in the CGC stock price, Canopy extended the warrants’ expiration date to November 2023 for the first tranche and November 2026 for the second and third.
These warrants are priced at higher levels than Canopy’s current trading price. But if the company rebounds, Constellation stands to reap much of the upside.
Tread Carefully With CGC Stock
Even after falling from $52.74 per share down to below $20 a share, CGC stock is not cheap. High expectations for Cannabis 2.0 continue to be priced into shares. Investors today can make a bet that infused beverages and edibles pay off. But it’s important to note the impact of Constellation’s de-facto control of the company.
So what’s the play? Buy Canopy Stock if you’re willing to stomach the risks. But other pot names selling at lower valuations may enable you to make that bet at a more reasonable price.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.