After a sharp decline starting in April 2019, Canopy Growth (NYSE:CGC) stock has remained sideways over the past four months. The markets seem to be in a “wait and watch” mode as the company and cannabis industry at large continue to face challenges. Considering the broader factors of cannabis oversupply, cash burn and regulatory hurdles, headwinds are likely to sustain through 2020. This makes Canopy unattractive even after the big correction because CGC stock will likely remain sideways to lower through 2020.
Starting with the industry, data suggests that dried cannabis inventory has continued to climb. For Canopy Growth, this would imply sustained pressure on average selling price of dried cannabis. Therefore, operating level margins are likely to remain depressed.
In addition, dried cannabis sold for medicinal purpose has remained low through 2019. The key reason is lack of evidence backed medicinal cannabis products. It will take years before medicinal cannabis gains traction through clinical research and subsequent FDA approvals.
Equity Dilution Can Keep CGC Stock Subdued
As of March 2019, Canopy Growth reported cash & equivalents of 4.5 billion CAD. The company’s cash & equivalents declined to 2.7 billion CAD for September 2019.
This implies a cash burn of 1.8 billion CAD in two quarters. Considering the same rate of cash burn, Canopy Growth would require funding through equity infusion or debt in 2020.
With positive free cash flow still few years away, I believe that Canopy Growth will dilute equity than leverage. Therefore as the equity base widens, I expect CGC stock to decline.
I also believe that the possible equity infusion in 2020 will not be the last. With global expansion, clinical trials and launch of recreational products, the company is very much in an investment stage. Therefore, selling & marketing expenses coupled with R&D expense will remain high.
Related to R&D, I want to come back to medicinal cannabis. Peter Grinspoon, a medicine teacher at Harvard Medical School, opined that “we need more research but CBD may be prove to be an option for managing anxiety, insomnia, and chronic pain.”
Therefore, there is potential for growth in the medicinal cannabis segment. However, clinical trials followed by FDA approval will provide authenticity on medicines. Until that happens, it would be optimistic to expect growth.
Impact of Delay in Beverage Launch
Canopy Growth recently announced that the launch of cannabis beverages will be delayed. According to the company, the “scaling process is not complete” and further updates will be provided on launch timeline with Q3 2020 results.
The company also believes that the delay will not have any material impact on FY20 revenue and I agree with that. However, my concern is on the real reason for the delay in launch on cannabis beverages.
Back in May 2019, Aurora Cannabis (NYSE:ACB) CEO opined that “The proven market is certainly not in beverage.” While I am speculating, it’s likely that the delay is to avoid investments in beverages and face a weak market demand.
I want to add here that in December 2019, Canopy Growth launched hemp-derived CBD products including softgels, oil drops and creams. With these products now launched in US markets, the demand outlook will be clear in the coming quarters. CGC stock is likely to react based on the revenue growth from these products.
The Bottom Line on CGC Stock
CGC stock is in a consolidation mode as the markets wait for the next meaningful trigger to move the stock.
Considering the factors discussed, there seems to be more concerns on a horizon than positives. Be it equity dilution or weak growth in medicinal cannabis, CGC stock is likely to react negatively.
In addition, expansion beyond Canada is likely to be slow with regulatory hurdles. Lack of research on long-term impact of recreational cannabis also acts as a hurdle.
In conclusion, cannabis might have potential in the long-term, but it’s optimistic to expect strong growth in the next few years. Market penetration will take time and companies will need to navigate an extended period of cash burn.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
