Canopy Growth (NYSE:CGC) and its cohort had a tough week last week. It started with a big bang for CGC stock, but then it crashed mid-week. It closed off the bottom Friday but the drop from high to low was 30%. My contention today is that it is still too early to catch the falling knife.
I do not have any new concerns about the business just because one rally failed. That’s because it is normal price action after a massive spike. Especially that it failed within an inch from the 2018 all-time high cluster. Stocks rarely burst through on their first visit back to accident scenes. A dip to reload is what the bulls need to break through once and for all.
These are neck-break speeds and they require caution. Besides, it is still up 60% this year and this is only February. I say this with a clear conscience because I respect their efforts. My only goal is to avoid the big potential drops for new positions. I do take both sides of the argument but each in due time. The fundamentals for Canopy and others have improved a lot. Long term, they are likely to succeed and onus is on management to prove it. Owning it for that reason is a viable thesis. Buying it now is technically sub-optimal, hence my apprehension.
CGC Stock Needs Political Help
The original hoopla about pots stocks was that they would disrupt dozens of industries. Consensus was that major conglomerates like Coke (NYSE:KO), Pepsi (NASDAQ:PEP) and even Procter and Gamble (NYSE:PG) would have to infuse products with cannabis. While cannabis companies have made headway in that direction, that prediction is not unfolding as fast nor in the manner investors hoped. Legalizing the stuff may give that effort a giant boost.
That’s not necessarily a bad thing because they can take their time to do it right. Hasty ventures could foil the true potential of the opportunities. Eventually old school companies will have to adapt if the legislators allow for it. This can only happen if this White House actually delivers on the hopes that investors have pinned on it already. The rally ever since Biden took the lead in November has been fierce. This sector could suffer a let-down if months pass with no action.
Mitigate the Risk
This is a lot of risk and it’s binary. I don’t like “hoping” for things to happen. I’d rather assess value based on current merit not future binary events. Regardless of how competent Canopy Growth management is, they cannot control what politicians do. That bunch has a history of disappointing their constituents. More often than not they fail to follow through.
For this I want to opt out of chasing CGC stock at face value and without protection. At the very least, if investors are itching to get in they should only take starter positions. This way they leave room for error in case there are more downside ahead. The options markets offer an alternative because there investors can create buffers.
For example, I can sell April CGC $30 put and collect $2.30 per share. This means that I won’t likely own shares unless the stock falls below my strike. Even if this happens I would break even 31% below current price. In that scenario, someone who buys shares today would be down that much already. I chose $30 because that is where the chart shows support. If the correction continues and CGC stock reaches it, that would make for a nice mid-term entry.
Cannabis Sector Has Many Leaders
In 2018 when the cannabis theme took flight, CGC hogged the attention on Wall Street. This was mostly due to the fact that it drew a $4.2 billion investment from Constellation Brands (NYSE:STZ). This meant that if there were to be a winner among the cannabis companies, CGC would be it. Having a cash coffer this big meant that they could overcome the obstacles ahead.
Now that the STZ investment headline has faded, so did the dominance by CGC stock. This would be especially true if the merger agreement between Aphria (NASDAQ:APHA) and Tilray (NYSE:TLRY) closes. The resulting company will have the largest revenue line in the world.
Moreover, the whole sector has gone through major transformations in the last two years. Most importantly, investor expectations are back to somewhat reasonable levels.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.