Despite Cost Cutting, Canopy Remains A Sell Due to Valuation

With shares trending lower, is Canopy Growth (NYSE:CGC) stock a buying opportunity? Don’t even think about it.

CGC stock
Source: Jarretera /

The company may be making smart moves restructuring its operations, but don’t expect upside anytime soon. The “Cannabisphere” remains a hot mess, to say the least. Canopy may be faring better than competitors like Aurora Cannabis (NYSE:ACB), but the better-capitalized pot stock is not immune to industry headwinds.

There remains too much supply and nowhere near enough demand. “Cannabis 2.0” hasn’t set the world on fire. Even the possibility of U.S. pot legalization remains a long-shot. The Trump administration remains against U.S. Federal legalization. And Democratic front-runner Joe Biden is on the fence (at best) regarding the issue.

So, what’s the verdict? Sell Canopy as shares head lower? A breadcrumb of good news could send shares higher. Yet, today’s turbulent market is looking for reasons to sell rather than reasons to buy. In other words, there’s no reason to take a contrarian position in this broken “story stock.”

Recent Developments and CGC Stock

Whether the Canadian market improves or not, cutting production is a step in the right direction. As this Seeking Alpha contributor recently discussed, the company’s marijuana harvest levels continue to exceed sales.  The gap between production and sales may be getting smaller. But, overcapacity remains a top issue.

New CEO David Klein is doing what he can to reduce the company’s cash burn. Constellation Brands (NYSE:STZ), Canopy’s largest shareholder, installed Klein (their former CFO) early this year to clean up house. Many factors are out of the company’s control. But, with improved financial discipline, Canopy Growth stands a better chance of weathering the storm.

As Investorplace’s Ian Bezek discussed February 25, expect further cost cutting. Typically, cutting costs can only go so far. Yet in this case, right-sizing the business could work out. With the company’s revenues continuing to grow, rationalizing the scale of the business could finally bring the company to profitability. If that were to happen, it would definitely move the needle for CGC stock.

With shares down more than 70% from their 52-week high, shares could pop on just a whiff of improvement. With markets reeling and the specter of cooling economic growth, is today the time to buy Canopy stock?

The answer remains, “no.” Canopy may be finally on the road to profitability (or at least positive EBITDA.) But valuation remains sky-high and there’s plenty of downside from here.

Valuation Makes Canopy A Sell

Pot stock valuations may be less frothy than they were a year ago. But, shares remain richly-priced considering industry uncertainty. Given their unprofitability, the enterprise value/sales (EV/Sales) ratio continues to be a key valuation metric.

CGC stock trades at an EV/Sales ratio of 14.6. While this is well below Cronos Group’s (NASDAQ:CRON) EV/Sales ratio of 20.6, it’s still well above valuations for Aurora, Tilray (NASDAQ:TLRY), and Hexo (NYSE:HEXO).

The latter three pot stocks have EV/Sales ratios well under 7. In other words, shares could fall by 50% before becoming fairly priced to peers. Of course, this may not be apples-to-apples. As I’ve mentioned before, the company and Cronos have higher valuations thanks to their deep-pocketed backers. Constellation, of course, in the case of CGC. Altria Group (NYSE:MO) in the case of Cronos.

The war chest provided by these blue-chip partners give both names more wiggle room. Yet, cash burn is reducing this edge. Until both companies post positive cash flow, shares could head to lower prices.

Canopy’s management is doing the right thing. But we can’t expect a turnaround to happen overnight. And with shares trading at a sharp premium to peers, why bet on a turnaround if you don’t get a discount for the risks?

Near-Term, Don’t Buy This Falling Knife

Bottom Line: now’s not the time to invest in CGC stock. The company’s new management may be making the right moves. But, it could be a while before we see the benefits. In the meantime, with markets trending lower, investors are looking for reasons to sell stocks, not buy them.

With Constellation’s backing, I don’t expect the stock to hit zero anytime soon. Soon enough, we may see shares hit a “fire sale” valuation. At that point, the stock could be a great contrarian play. But until then, Canopy remains a clear sell.

Thomas Niel, contributor to InvestorPlace, has been writing single-stock analysis for web-based publications since 2016. As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

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