3 Arguments For and Against Buying Canopy Growth
Once considered a taboo industry, marijuana is now big business. According to Cowen Group, arguably the most bullish of all Wall Street investment firms, the global cannabis industry could hit $75 billion in annual revenue by 2030, placing it on par with or ahead of the soda industry. To put things mildly, we just don't see growth stories like this come along all that often.
The big unknown is no longer whether the cannabis industry will be around 10 years from now. Instead, it's which pot stocks should be seriously given investment consideration. Topping that list just might be the world's largest marijuana stock by market cap and the first pot company to ever uplist to the New York Stock Exchange, Canopy Growth (NYSE: CGC).
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Sporting a more than $16 billion market cap, it's pretty evident that Canopy Growth has a fan base that believes there are plenty of reasons to buy. Then again, this is a company with 22 million shares held short as of Jan. 30, 2019. It's apparent that valid arguments can be made for Canopy Growth from both sides of the aisle, as you'll see below.
Three reasons buying Canopy Growth is a smart investment
The most logical reason to buy into Canopy Growth is because of the massive equity investment of $4 billion it received from Modelo and Corona beer producer Constellation Brands (NYSE: STZ). The investment was announced in mid-August, closed in November, and represented the third such time that Constellation had made a direct or indirect investment in the company. Upon closing, Constellation had a 37% stake in Canopy, with the warrants it received giving it the option at a future date to up its stake to as much as 56%. Not only does this cash infusion give Canopy more than enough capital to execute on its business strategy, which includes acquisitions, but it makes the company a serious buyout target by Constellation Brands a few years down the road.
Secondly, Canopy Growth is going to be a top-notch producer of cannabis, and as a result, it has landed itself an impressive number of supply deals. As of the fiscal third quarter, the company had more than 4.3 million square feet of licensed production space but has aspirations of having all 5.6 million square feet of growing capacity licensed by Health Canada this year. When fully operational, this should work out to north of 500,000 kilograms of yearly pot production. Having supply deals in place with all provinces, around 15% (or more) of the company's peak production should be spoken for each year.
Image source: Getty Images.
Thirdly, Canopy Growth brings intangibles to the table that most other pot stocks can't offer. Its Tweed brand is arguably the most established and recognized throughout Canada. It has multiple channels to sell its product, be it online or through physical retail stores that it owns. And unlike most marijuana stocks, Canopy is soon to have a very diverse revenue stream. Recently, the company was awarded a hemp growing and processing license in New York State that'll allow the company access to the United States' now legal and burgeoning hemp business.
Long story short, there are a lot of very good reasons for Canopy Growth to be the world's largest publicly traded pot stock.
Three arguments why you'll regret buying into the Canopy Growth story
However, there's another side to Canopy Growth that you ought to know and that isn't so palatable to investors. Here are three reasons you could regret buying into this growth story.
For starters, Canopy's intangibles can get lost in the shuffle if you happen to come across its income statement, which is bogged down by hefty operating losses. In the company's recently reported third-quarter results, Canopy tallied almost 170 million Canadian dollars (CA$170 million) in operating expenses, which included a more than quadrupling in general and administrative costs and a near-quintupling in sales and marketing expenses. All told, Canopy delivered an operating loss of CA$157.2 million in the fiscal third quarter. Through the first nine months of its fiscal year, operating losses have ballooned past CA$400 million, demonstrating what a fundamental mess Canopy Growth is at the moment. And, as the icing on the cake, profitability may not happen in 2020, either.
Image source: Getty Images.
The second red flag for Canopy Growth is the company's overwhelming focus on the recreational weed consumer. In the company's fiscal third quarter -- the first quarter to have postlegalization sales in Canada -- Canopy recorded CA$71.6 million in adult-use weed gross sales and just $18.6 million in gross medical marijuana sales, down CA$1.7 million from the year-ago quarter. Although the recreational pot market has a much larger consumer pool, these are typically lower-margin customers since they focus on dried cannabis flower. If Canada follows the same path as Colorado, Washington, and Oregon in the U.S., oversupply and commoditization will wreak havoc on Canopy's already challenged margins.
Last but not least, many optimists are assuming that we'll see a quick and orderly transition to legal sales channels for marijuana in Canada -- but this may be far from the reality. Health Canada has been contending with a mountain of cultivation license applications and sales permits, which, in many cases, is slowing down the ability of growers, processors, and packagers to bring product to market. This is a big reason why cannabis shortages have occurred in nearly every Canadian province since mid-October. In 2019, an estimated 71% of all marijuana sales will still be conducted on the black market, which means Canopy Growth's sales projections in the near and intermediate terms are probably too aggressive.
With these arguments in mind, where do you stand on Canopy Growth?
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.