As we close the books on 2019, what does the future hold for Canopy Growth (NYSE:CGC)? The “Cannabisphere” maelstrom continues. Canopy stock is down 60% from its 52-week high. But thanks to new product launches, and a new CEO courtesy of backer Constellation Brands (NYSE:STZ), shares could rebound in the coming year. As long as the macro factors play out.
Constellation may now be in the driver’s seat. However, they do not control the destiny of the Canadian pot market. Waiting for bureaucrats to untangle the red tape remains key for the licensed producers (LPs). Therefore, upside in Canopy Growth is contingent on this factor.
But that’s not all! The Canopy story going forward requires “Cannabis 2.0” to meet expectations. The company is betting big on infused beverages, and these new products need mass consumer adoption to support the stock’s current valuation.
Is all this possible in 2020? Certainly. But, given the current valuation, taking your time with Canopy Growth may be the best call. Let’s dive in, and see what’s in store for Canopy at the dawn of the 2020s.
Cutting The Red Tape
Oversupply and lack of retail distribution are key challenges for Canadian pot stocks. Despite a large legal market, licensed retail locations remain scarce. Meanwhile, the illicit pot market continues to dominate. If you are a marijuana user in Ontario, would you waste your time finding one of 24 legal locations? Especially when a black market delivery service is just a phone call away?
Overall, progress is being made cutting the red tape. The Ontario Government is loosening regulations on retail locations, and eliminating the cap on total stores in the province is a step in the right direction.
But, retail distribution isn’t the only issue plaguing “Big Pot”. Oversupply remains a concern, but the introduction of infused beverages, edibles and vapes could help drive demand next year. Yet, we may not see equilibrium until 2021 at the earliest.
However, supply issues may not be such a big deal. The important thing for Canopy Growth in 2020 is to turn “Cannabis 2.0” speculation into tangible results. Canopy expects its 2.0 products to hit shelves next month, and results for fourth quarter 2020 could make or break the Canopy story.
In the meantime, we need to separate hype from fact. Pivoting to valuation, we can see that investors continue to have high expectations for Canopy stock. Shares may be down from past highs, but they are not in the bargain basement.
Valuation Remains Rich
Canopy Growth remains richly valued. Shares trade for around 25 times trailing twelve month (TTM) sales. By comparison, Aurora Cannabis (NYSE:ACB) trades for 10 times trailing sales. Tilray (NASDAQ:TLRY) and Hexo (NYSE:HEXO) trade at similar valuations, and Cronos Group (NASDAQ:CRON) is the only major pot stock trading at a higher valuation at around 70 times trailing sales.
On the other hand, this premium makes sense. Canopy Growth has backing from a deep-pocketed partner in Constellation. Likewise, Cronos has backing from tobacco giant Altria Group (NYSE:MO). As a result, both have significant cash on hand.
Meanwhile, companies like Aurora remain poorly capitalized. In other words, Canopy and Cronos can better weather the Cannabis maelstrom, and they could even profit from the wreckage. Companies like Aurora may have to sell prized assets at fire sale prices to stay afloat.
Dilution was a prior concern of mine for Canopy Growth, as Constellation holds a large slug of warrants to buy more Canopy shares. But, MKM Partners’ Bill Kirk recently noted that acquiring majority ownership of Canopy Growth could jeopardize Constellation’s U.S. federal alcohol licenses. That is to say, Constellation won’t consider growing their Canopy stake until pot is fully legal in the United States.
Yet, Constellation could still profit at the expense of outside investors. Long term, shares could rally back above the warrants’ strike price — and given these warrants don’t expire until 2023 and 2026, this remains a possibility. Keep this in mind when determining Canopy’s potential value a few years down the road.
Another issue to consider is that “pot stock” prices could be skewed by short sellers covering positions. The major names are up big from their lows, and shorts are throwing in the towel. This creates even more buying pressure, as shorts who didn’t cover early scramble to close out their positions.
Take Your Time Before Buying Canopy Growth
2019 was a killer for Canopy Growth shares, but all bets are off for 2020. Canadian regulators are fixing the mess they created. Add in the “infused beverage” catalyst, and investors could rush back into the stock.
Yet, today’s price may not be your best entry point. Wait for the shorts to clear out.
With strong capitalization, Canopy Growth is a “safer” pot stock play. But, to tilt the odds in your favor, take your time before buying.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.