After a horrendous quarter, Canopy Growth (CGC) fell to new yearly lows below $14. The stock has rallied substantially in the last couple of days as the market saw Canopy Growth as a bargain following a dip from highs above $50. The reality is that the large cannabis company still has too many uncertainties and burns far too much cash for investors to hold the stock following this rally to $20.
More Reasonable Value
The basis for Bank of America’s recent upgrade on Canopy Growth was a more “reasonable” stock price. Analyst Christopher Carey became more bullish on the stock due to consensus estimates being more achievable now and even possibly beatable. (Check out Carey’s track record, on TipRanks)
The problem here is the stock value jumped back above $7 billion. Updated analyst estimates have pushed FY20 revenues down to only $311 million with FY21 ending in March targets down to $638 million.
Making a case for buying the stock up at $20 is impossible. The cash hoard of $2 billion is a big question mark with quarterly adjusted EBITDA losses of $118 million. Years of ongoing losses will burn a lot of the cash cushion here.
Cantor analyst Pablo Zuanic believes the stock will remain under pressure in the near-term, as he reiterates a Neutral rating alongside a C$18.90 or USD$14.22 price target, which implies about 25% downside from current levels. Zuanic noted, “We see better value elsewhere in the group. Canopy says it is in the best position to benefit from the global opportunity, but so far lags in exports behind TLRY and ACB.” (To watch Zuanic’s track record, click here)
My view is that investors shouldn’t value the stock based on a enterprise value that includes more than $1 billion in cash. With an enterprise value of over $6 billion, the stock trades at nearly 10x lowered FY21 sales estimates. The value isn’t reasonable at all.
U.S. Laws
Another reason for Canopy Growth rallying was the U.S. House Judiciary Committee passing the MORE Act. The bill sets the stage for an eventual discrimination of marijuana.
The democratic committee approval doesn’t alter the inability of other acts to pass the Republican led Senate that is unlikely to approve laws loosening regulations on cannabis. The SAFE banking act has failed to gain any traction in the Senate after obtaining House approval back in September.
The benefit to Canopy Growth is the call option to purchase Acreage Holdings once cannabis is federally legal. The U.S. multi-state operator gives the company access to the largest global cannabis market in the world with a target of reaching $16 billion in annual sales next year.
The future U.S. division reported Q3 revenues of $42.2 million. The problem for Canopy Growth is the Q3 adjusted net loss of $15.0 million and adjusted EBITDA loss of $9.1 million.
The last thing Canopy Growth needs is to add another money losing position to their income statement. The negative adjusted EBITDA margins of 21.6% won’t help the stock rally.
Not to mention, the best way to play the U.S. federal approval of cannabis is via buying stock directly in Acreage. The deal offers 0.5818 shares of Canopy Growth placing the value to an Acreage shareholder at $10.76 versus the current stock price at only $6.00.
Takeaway
The key investor takeaway is that Canopy Growth has no basis to rally with the current financial prospects of the company whether based on valuation or U.S. legal aspects. Investors should look to fade the rally of the large cannabis money losing stock trading at nearly 10x forward sales estimates.
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