Cracks Are Forming in Canopy Growth (CGC) Stock

Canopy Growth (CGC) has generated more sizzle than steak over the last year or so, and I think the chinks in its armor are going to start to show over the next year, as it finds itself under performing, primarily because of its heavy reliance upon Canadian recreational pot, and its relative weakness in the global medical cannabis space, where the future growth of the marijuana industry resides.

For now, the market has been forgiving of Canopy because of the seemingly endless reporting on the $4 billion investment made by Constellation Brands in the company. But I think that hype is starting to fade, as the market is starting to look under the hood more, and the reality isn’t aligning with the media hype surrounding Canopy Growth. After all, how long can the company ride that horse?

The other negative associated with the deal is it created far too great expectations and irrational exuberance for the company, which with the first major weakness will put heavy downward pressure on its share price and value. When, not if that happens, it’ll take time for Canopy to dig itself out of the hole it finds itself in.

Recreational Canadian pot

In its last earnings report the company reported revenue of C$83 million after excise taxes; a gain of 282 percent year-over-year, on sales of 10,102 kilograms. Most of that came from recreational pot sold in Canada.

Gross revenue was $97.7 million, with Canadian recreational pot accounting for C$71.6 million of the total. Overall medical cannabis sold came to $18.6 million, less then the total medical cannabis sold in the same reporting period the year before. Medical cannabis sold in Canada was down 18 percent year-over-year.

Its major competitor Aurora Cannabis on the other hand, split recreational and medical sales in its latest reporting period at close to 50/50.

While in the long term this would be a major problem for Canopy Growth if it isn’t rectified, in the short term it could help the company generate more revenue than its peers. That said, it needs to be understood that the recreational pot market in Canada has significant limitations in the overall scheme of things, and once competitors ramp up production and the sales channel is improved, Canopy will reach a revenue ceiling rapidly.

With that in mind, its exposure to Canadian recreational pot will probably remain a significant short-term catalyst, but it could rapidly change on the company, exposing its weakness in medical pot and international exposure.

Acreage Holdings deal

The latest headliner for Canopy Growth was its bid to acquire Acreage Holdings (ACRGF); an attempt to position itself for immediate penetration of the U.S. market if cannabis is ever legalized at the federal level.

It did, once again, give the company a lot of media exposure, and cause some to question the strategy of Aurora Cannabis, which has been reluctant to force itself into the U.S. market at this time. I think that’s a wiser move because the federal legal situation in the U.S., in spite of media spin, probably is much further away than most people think.

Canopy agreed to pay cash and stock valued at $3.4 billion for Acreage. It could be sitting on that deal for many years, while Aurora in particular widens its global medical cannabis lead, and continues to be the market leader in production capacity.

Again, the problem to me is Canopy is getting most of the media hype, with a lot of pundits and commentators making weak assertions it is the market leader. Based upon valuation it is, but that’s not going to remain that way for long, in my opinion.

All that said, Canopy does have the strength of keeping its name in the public eye, and it has been rewarded in its share price. The problem with hype that can’t be backed up, if that’s how it plays out, is the company that exists in a bubble can experience a terrible bursting of that bubble.

Conclusion

Canopy is in a race to transition to more of an international and medical cannabis player, rather than being so heavily exposed to Canadian recreational pot.

Even so, it has also focused a lot on the CBD and hemp markets, which I’m not convinced are going to be as significant as some believe they are. That’s especially true in the infused drink market, which the financial media have been hyping a lot.

That doesn’t mean Canopy Growth isn’t going to do well in the near term, because it probably will, until the Canadian recreational market starts to hit a ceiling. After that, if it hasn’t made significant inroads in other segments of the industry, it’s going to struggle to find sustainable growth. If it stumbles on the recreational side anytime soon, it’s going to take a huge hit, a hit I believe will take time to rebound from.

My view is that of all the cannabis companies, Canopy Growth may be the most overvalued and over-hyped, primarily because of the cash infusion from Constellation and the media coverage associated with Acreage. In reality, much of that has yet to pay off for Canopy. That doesn’t mean it won’t, but I think there is far too much priced in when there is so much yet to be proven on capital allocation and how long it’ll take for the U.S. to legalize cannabis at the federal level, if it ever does.

At this time there is far too much assumption that it’s only a relatively short time before cannabis is legalized in the U.S. That’s because mainstream and alternative media have been pushing it. But when you do some research behind the push, there is a significant amount of resistance to the idea, and we haven’t see the push back from the opposition yet. It will come.

In the short term, specifically concerning its upcoming June earnings report, if Canopy is able to meet or exceed expectations, it is going to make a nice run, especially after Aurora Cannabis reported mixed results.

On the other hand, if it disappoints because of its perceived market lead, it probably will take a bigger hit than Aurora has.

The major things to consider with Canopy Growth is the risk associated with its heavy exposure to Canadian recreational pot, its prior lack of urgency to expand rapidly internationally, and its over-hyped bid for Acreage, which could take much longer to add to the company’s performance than the market now thinks.