Could the Pain Finally Be Over for Canopy Growth Stock?

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Many investors regard Canada-based Canopy Growth (NYSE:CGC) as one of the best cannabis companies. CGC is the largest marijuana stock by market cap. But in 2019, its large size  did not help support Canopy Growth stock, as the shares fell 21% last year.

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Although 2020 may turn out to be a better year for Canopy Growth stock, I believe it’s still too early to invest a meaningful amount of money in CGC stock or in most of its peers. CGC is expected to report its fiscal third-quarter earnings in February. I’d encourage potential investors to analyze the company’s Q3 results before buying Canopy Growth stock.

Canopy Growth’s Q2 Results

On Nov. 14, CGC released its Q2 results.  Investors were disappointed as its revenue and loss per share were were weaker than analysts, on average, had  expected.

During the quarter, Canopy’s loss from operations totaled $265.8 million CAD. Its gross margin came in at negative 13%, considerably below the positive 33% figure it had reported a year earlier.

One bright spot was that CGC still had 2.7 billion CAD of cash and cash equivalents as of Sept. 30. Canopy Growth still had a great deal of cash because it had received a $4 billion investment from alcoholic beverages giant Constellation Brands (NYSE:STZ) in 2018. Constellation now holds a 38% stake in CGC, which had trouble managing its cash flow.

New Leadership at CGC

In mid-January, Canopy Growth will be welcoming a new CEO, David Klein, who will step down from his current position as CFO of Constellation Brands to take the post at CGC. InvestorPlace columnist Jonathan Berr has written a detailed piece on what shareholders could expect from CGC stock in the early days of Klein’s tenure.

Klein’s appointment shows that CGC’s board would like the company to tighten its belt and put its financial house in order.

Canopy’s loss from operations hit 388.9 million CAD in the first six months of fiscal 2020. Wall Street has been increasingly concerned that Canopy Growth and other cannabis companies are spending too much money.

Although CGC may not not achieve profitability in the near future, its cash burning will have to come to an end.

The owners of Canopy Growth stock hope that the cannabis-infused beverages and food that CGC will  begin selling in Canada soon will enable it to grow more rapidly.

Investors are also hopeful that the company’s international operations will become more successful in 2020. More countries are legalizing the use of cannabis for medicinal purposes. And Canopy Growth has a presence in 16 countries other than Canada.

However, in Q2, CGC’s international medical cannabis business only generated 18.1 million CAD of revenue. That number has to grow substantially before investors can get excited about its overseas business.

Supply and Demand Issues

Producing cannabis is capital-intensive. As a result, cannabis firms make substantial initial and ongoing investments.

They are also vulnerable to supply and demand issues. In 2019, a wide range of Canadian regulatory logjams resulted in supply problems for CGC and its peers.

Plus, most of the demand for cannabis is currently limited to Canada where there is still a resilient black market. Wall Street is now seriously questioning whether the revenue of CGC and its peers can grow much, given the weakness of the Canadian cannabis market. Consequently, the Street has become much less upbeat on Canopy Growth stock and other cannabis stocks.

In Q2, CGC sold only about 25% of the cannabis it produced. In its earnings release, CGC said:

“The last two quarters have been challenging for the Canadian cannabis sector as provinces have reduced purchases to lower inventory levels, retail store openings have fallen short of expectations, and Cannabis 2.0 products are yet to come to market.”

Although marijuana is still illegal under  U.S. federal law, for over a year hemp has been legal under U.S. law. And in January 2018, Canopy Growth obtained a license to process and produce hemp products in New York State.

U.S. hemp production has not yet contributed to Canopy’s bottom line. CGC and its peers may indeed ultimately benefit from the legalization of hemp However, it will probably be several quarters before Canopy’s investments pay off and turn into profits that could positive impact Canopy Growth stock.

The Performance of CGC Stock

Canopy Growth stock and its peers can be quite volatile.

Over the past year, CGC stock has tumbled 30%. On Apr. 29, Canopy Growth stock reached  a 2019 high of $52.74. It’s now trading below $20.

After hitting a 52-week low of $13.81 on Nov. 18, CGC stock rebounded. Investors who bought Canopy Growth stock near its lows and are still holding onto the shares may want to lock in some profits at this point. I believe the recent rally of CGC stock was partly due to investors’ hope that Constellation Brands could acquire the shares of Canopy Growth stock it doesn’t already own.

However, that  is not likely to happen any time soon. Constellation is likely to give CGC’s new CEO ample time to streamline the cannabis producer  and wait for a more opportune time to acquire the company. By then, CGC stock may be lower than it is now.

Those considering investing in Canopy Growth stock may want to start buying shares when the stock is trading for $15 -$16 . They should expect to hold the position for several years. In the meantime, expect  CGC stock to be very volatile.

The Bottom Line on CGC Stock

There is still a lot of confusing hype surrounding the potential of cannabis leaders like Canopy Growth. After most marijuana stocks tumbled 60% to 90%, it certainly looks like the bubble has popped.

But CGC’s revenue and cost structure issues may not disappear in 2020.

Hope springs eternal. Yet CGC stock will need a strong catalyst to make it attractive in the eyes of many long-term investors. Until then, CGC is likely to be volatile with a downward bias.

Eventually, Canopy Growth  has to align its practices with the reality of the marijuana market. For now, I’d keep Canopy Growth and the industry on my watch list.

As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

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