Canopy Growth (NYSE:CGC) stock popped about 10% higher in early August after the cannabis giant reported first quarter results. The numbers sailed past expectations and comprised favorable underlying trends, including accelerating revenue growth and falling expenses. In the big picture, Canopy Growth’s earnings were strong enough to confirm that CGC stock is a buy here.
The reality is that global demand for cannabis is huge, and all of that demand is gradually shifting into the legal channel. Canopy Growth finally has a strategy in place to capture that shifting demand, while also maintaining a slim operating model that allows for profitable growth.
Accordingly, Canopy Growth has bright long-term growth prospects. Over the next 5 to 10 years, revenues will roar higher and margins will improve. Today’s losses will turn into tomorrow’s profits.
Canopy Growth stock isn’t priced for this. Indeed, by my numbers, CGC stock isn’t fairly valued relative to the company’s long-term growth prospects until about $30.
So I say buy CGC stock.
Here’s a deeper look.
Strong Canopy Growth Earnings
Canopy Growth’s first quarter earnings report was pretty strong. Revenues rose 2% sequentially and 22% year-over-year, very impressive numbers considering the quarter comprised April, May and June — or the heart of the Covid-19 pandemic in North America and Europe, Canopy’s two core markets. Strong revenue growth herein implies three things.
One, demand for cannabis globally is robust, and largely recession-resilient, similar to demand for alcohol.
Two, thanks to legislation around the world changing to more openly adopt legal cannabis, all of this demand is gradually pivoting into the legal channel, as more cannabis retail stores open up and as consumers can openly buy weed online (see ShopCanopy.com).
Three, Canopy has the right products in market — vaporizers, beverages, dry bud, etc — to capture this robust and shifting demand.
Gross margins in the quarter did come in weak, at around 7%. But that’s mostly because of one-time Covid-19 effects causing under-utilization at the company’s large-scale production facilities. When those facilities are fully utilized, Canopy has shown it can net 40%-plus gross margins. Management expects gross margins to return to those levels shortly.
More importantly, despite that huge drop in gross margins, adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) loss was relatively flat year-over-year. That’s due to management’s hyper-focus on gutting the expense model, removing unnecessary spend, streamlining investments, and running a slimmer operating model. On top of 22% revenue growth in the quarter, adjusted opex dropped more than 10% year-over-year.
Over the next few quarters, then, sustained strong revenue growth will couple with this immensely positive operating leverage and rebounding gross margins to spark meaningful profit improvements.
That’s the sort of dynamic which could get CGC stock to rally in a big way.
Canopy Growth Stock Is Undervalued
By my numbers, huge profit improvements over the next few quarters could spark a ~60% rally in CGC stock.
Looking at the big picture here, I see five things happening:
- Rising consumer demand for alternative recreational drugs — like cannabis — coupled with supportive legislation will power huge growth in the global cannabis market over the next 5 to 10 years, leading to this market measuring $40+ billion by 2024, and potentially $60+ billion by 2030.
- Canopy Growth continues to leverage its bigger-than-peer production facilities, first-mover’s advantage, strong product line-up and even stronger partnerships to sustain leadership in this $60+ billion global cannabis market at scale. Something like 10% market share seems doable, implying $6+ billion in sales by the end of the decade.
- Economies of scale pushes gross margins up towards 50%, roughly where they sit in the alcoholic beverage industry today.
- Management’s commitment to cost-cutting results in continued positive operating leverage and opex rate compression to 30%. On 50% gross margins, that implies 20% operating margins, which is also consistent with the alcoholic beverage industry.
Assuming those things happen, my modeling suggests that Canopy has a visible opportunity to net $3 in earnings per share by 2030.
Based on a 20-times forward earnings multiple, that implies a 2029 price target for CGC stock of $60. Discounted back by 8.5% per year, that implies a 2020 price target for CGC stock of nearly $29.
That’s roughly 60% above the current CGC stock price.
Bottom Line on CGC Stock
Canopy Growth is a long-term winner that the market is sleeping on. I don’t think the market will stay asleep on this name for much longer.
Sustained strong revenue growth on the back of geographic expansion, new product launches, evolving legislation, rebounding gross margins, and huge expense cuts will power significant profit improvements at Canopy Growth over the next few quarters.
Such huge profit improvements will illuminate a bright future for the cannabis giant. The market will wake up. See that bright future. And CGC stock will pop.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the best stock pickers in the world by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long CGC.
