Did Canopy Growth Stock Just Have a Dead Cat Bounce? 

Stocks to buy

Canopy Growth (NYSE:CGC) stock jumped more than 12% on the final day of 2019, its best single-day performance since early December. 

Source: Shutterstock

While it’s easy to get excited about the one-day romp, most of the other major Canadian cannabis companies had good days on Dec. 31, with Aurora Cannabis (NYSE:ACB) and Aphria (NYSE:APHA) gaining 13.1% and 10.4%, respectively. The fact that many names in the sector climbed indicates that the gains may have been nothing more than a much-needed relief rally. 

So the question for Canopy Growth shareholders is whether the latest move was a dead-cat bounce or the beginning of something bigger. 

Here are some arguments on both sides of the issue. 

Canopy’s Latest Jump Is Temporary

Canopy Growth’s most significant problem is the black market. 

While wholesale prices of pot have dropped by approximately 17% since the legalization of dried cannabis in October 2018, black market prices have remained much lower than those of the legal retail stores in Canada. That situation, combined with a shortage of retail stores, is why the black market still accounts for a majority of Canadian cannabis sales.

“There’s a very strong resistance to the legal stores in the sense that a) it’s more expensive and b) there aren’t enough of them. (Buyers are)  not close to them, so they just deal with their local guy like they always have,” said Robin Ellis, the co-founder of a Toronto cannabis retailer. 

Producers of dried cannabis built up the capacity to meet projected demand, but the lack of retail locations in Ontario, Canada’s most populous province, led to severe surpluses of legal cannabis supplies. 

Although Ontario scrapped its silly lottery system for awarding new retail stores in favor of an open-market system that allows anyone to apply to open stores, the new system only started on Jan. 1. It won’t meaningfully increase cannabis sales until the second half of this year. 

In the meantime, Canopy has ramped up its spending to get its beverages and edibles into the hands of consumers, It’s also launched its first hemp-derived CBD product in the U.S.. But InvestorPlace contributor Mark Hake thinks these initiatives will continue to hurt the company’s margins

In the first six months of fiscal 2020, Canopy Growth’s adjusted EBITDA losses were 248 million CAD, three times larger than in the same period a year earlier. 

Until the company’s new products improve its results, it’s hard to imagine investors paying more than the current prices to own the company’s stock. 

Canopy’s Stock Will Rally Much Further

In my last article about Canopy Growth in early December, I recommended that investors ignore the class-action lawsuits springing up against the company due to its falling stock price and increasing losses. 

I felt that the company was wise to let its lawyers deal with the legal sideshow while it focused on growing its business. Most importantly, I thought it needed to hire a CEO who could  help reignite the company’s growth.

I didn’t believe that Canopy Growth would hire a new CEO by the end of the year.  But true to its word, on Dec. 10 it announced that Constellation Brands (NYSE:STZ) CFO David Klein would take over as Canopy’s permanent CEO on Jan. 14. 

Portfolio manager Tim Seymour was upbeat about Klein. 

“This appointment of truly a consumer products CEO, someone who knows the CPG world very well and someone who knows this company very well, is very exciting, I think he’s the right man for the job,” Seymour told CNBC after the announcement. 

I second that emotion. 

Klein’s been chairman of Canopy Growth since November. Before that, as Constellation’s CFO, he was very knowledgeable about Canopy, in which Constellation had invested billions of dollars. As a result,  his transition into the CEO position will be easy. Furthermore, Canopy Growth’s current CFO also came from Constellation, so its two top executives will already be well-acquainted with each other. 

They can hit the ground running.

Over the long-term, I believe that Canopy Growth’s current financial position puts it heads above most of its Canadian competitors. Now that it has  the right CEO in place, it can return to focusing on growth while also boosting its profitability.

Its pathway to profitability might be a little blurry at the moment, but it will get there. In the meantime, the volatility of its stock is unlikely to disappear anytime soon. That said, I do believe that the shares can reach $30 or more in the next 12 months. 

I believe that Caopy’s rally will continue.

At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.



Articles You May Like

Introducing StockTracker Master Class Volume 1