Cannabis stocks have been on fire since the U.S. election. Five states passed legalization initiatives, and Democrats will be regaining control of the White House. But even after the big recent run in cannabis stocks, most names aren’t anywhere near peak prices. Canopy Growth (NASDAQ:CGC) has been the best-performing stock among the “big four” Canadian legal producers this year.
Analysts and experts say cannabis stocks still have plenty of room to run. Cannabis growth rates in the U.S. market are robust. Canopy is the biggest name in Canada, has major exposure to the U.S. and is even a potential buyout target for its major financial backer.
CGC Stock Growth Story
Canopy is the world’s largest cannabis producer. The company is also generating some impressive growth numbers.
Earlier in November, Canopy reported 77% revenue growth in its fiscal second quarter, far exceeding analyst estimates. The company also reported a much narrower-than-expected earnings per share loss as it continues to work on cost-cutting measures.
Canopy reported a 178% increase in Canadian recreational sales in the second quarter and is gaining share from competitors. Canopy now holds 15.5% of the entire recreational market share in Canada, up 2% from the first quarter.
Canopy’s gross margins jumped from 7% in the first quarter to 19% in the second quarter. Bank of America analyst Bryan Spillane says Canopy’s margins will likely double from their current levels over time to around 40%.
“We see mgmt. changes, right-sizing of operations and its enviable cash and share position as all reasons to believe that Canopy can be a [long-term] leader in the cannabis sector,” Spillane says.
In the near term, Spillane says trends in the U.S. market are encouraging.
“Given Biden’s projected win as reported by major media and ballot measure approvals in five U.S. states, we see the likelihood rising for U.S. federal decriminalization/descheduling of marijuana and more U.S. states to potentially move towards legalization,” he says.
Bank of America has a “buy” rating and $27.06 price target for Canopy stock.
Canopy’s Unique U.S. Exposure
The Canadian cannabis market is great, but most experts see the U.S. market as the grand prize. Tim Seymour, founder and chief investment officer of Seymour Asset Management, says the price gains in cannabis stocks since the election are just the tip of the iceberg.
Seymour says the “top-line growth story is 30-40%” for leading cannabis stocks. Unfortunately, Seymour says investing in the cannabis space these days is very tricky.
First, many of the top Canadian companies don’t have a lot of exposure to the U.S. That’s not a problem for Canopy due to its conditional buyout of Acreage Holdings (OTC:ACRHF). The second marijuana is legalized federally, Canopy acquires Acreage. Acreage just reported 42% revenue growth and 42.5% gross margins in the third quarter.
Second, many cannabis companies have wrecked their balance sheets to expand their businesses. Seymour says one of the biggest reasons why his Amplify Seymour Cannabis ETF (NYSEARCA:CNBS) has outperformed other cannabis ETFs in 2020 is because he heavily weighted stocks with the best balance sheets.
“It was about finding the companies that actually hadn’t levered their balance sheet or put a bunch of dilutive equity warrants in their structure,” Seymour says.
Not surprisingly, CGC stock is the second highest-weighted stock in Seymour’s fund.
One of the reasons Canopy’s balance sheet is so healthy is because it has the financial backing of minority investor Constellation Brands (NYSE:STZ). I believe Constellation adds another potential bullish catalyst for Canopy. I wouldn’t be surprised for Constellation to make a full buyout bid for Canopy at some point. That buyout catalyst could even come when U.S. legalization appears imminent.
How To Play It
The cannabis market in the U.S. and Canada will likely continue to be volatile and unpredictable over the next several years. Investors should anticipate political and regulatory headline risk. Investors should expect bullish and bearish academic research on marijuana. They should certainly expect pharmaceutical companies to fight against U.S. federal legalization with every resource at their disposal.
As always, Wall Street analysts will be issuing upgrades and downgrades that will rattle the market. But I urge investors not to lose sight of the long-term outlook for CGC stock.
If you believe cannabis will ultimately be legalized in the U.S. and cannabis consumption is trending higher worldwide, Canopy should be the first stock you buy. I would recommend diversifying your cannabis investment by adding a handful of other top Canadian and U.S. producers as well. But Canopy should be a core cannabis stock holding for the long-term.
On the date of publication, Wayne Duggan held a long position in CGC.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. He is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market.
