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Cannabis Stock Canopy Growth (CGC) Is a Winner, but Heed Valuation Risk

When is the right time to buy a marijuana stock, and which marijuana stock should you buy?

The answer may depend on timing — and scale.

The marijuana industry is experiencing explosive growth right now — in pretty much every respect other than profitability. Companies including Canopy Growth (CGC), Aurora Cannabis (ACB), the fantastically-named “Green Organic Dutchman” (TGODF) are rapidly ramping up production capacity in a race to satisfy demand, but at the same time, they’re creating the risk of an imminent production glut that will pressure prices.

In fact, says Desjardins analyst John Chu, marijuana “prices are expected to remain under pressure for several years. We forecast overall realized prices for flower to fall ~30% over the next four years, with prices for recreational dried flower falling in the mid-20% to mid-30% range.” And not just that — Chu even sees “prices for medical products and higher value-add (oils and edibles), and international prices [falling] in the 20–30% range.”

High start-up costs combined with a price war seems like a recipe for severe attrition among the multiple cannabis companies coming to market. Given the prospects for perhaps multiple companies going under, Chu has begun a hunt for the likely survivors — and leaders — of this market. And right now, the clear leader, by market capitalization and indeed by quality says Chu, is Canopy Growth.

Canopy “has size, scale, a major JV partner” in the form of beverages giant Constellation Brands, and a “war chest of more than C$4b” that it can use to grow the company, argues Chu. At $17.2 billion in market capitalization, it’s far and away the leader in valuation (nearly twice the size of Aurora Cannabis), and likely to “remain a leader and trailblazer in the sector for many years to come.”

In Chu’s just-published score card ranking marijuana companies on 24 separate attributes, scoring each attribute with 0 to 5 points, Canopy Growth outscores all comers, garnering 101 out of 120 total possible points. (Aurora Cannabis came in second with 89). Canopy scores well on overall size, medical marijuana recreational marijuana market positioning, management, product portfolio breadth, brands, retail and clinical presence, supply agreements, innovation, clinical trials, patents, partnerships, hemp sales, international presence, positioning to invade the US market, the strength of its balance sheet, and being “Good Manufacturing Compliant” (GMP) under EU standards.

All that being said, Chu does have one reservation about investing in Canopy Growth, and curiously, it’s tied to the very same fact that marks Canopy as the industry’s leader — its large market capitalization.

Canopy Growth may be valued at $17.2 billion, but until the company starts earning some profits, it’s not clear that the company is actually worth so much. Unfortunately, warns the analyst, although Canopy may have “potentially more revenue opportunities” than the competition right now, the “sightline to profitability” for Canopy “appears murky, with high operating costs “expected to be a drag on margins … at least in the short term.”

Granted, eventually Chu expects the marijuana market to settle down and earn good profits — as much as 40% to 70% gross margins for dried flower product, 60% to 70% for cannabis oils, and mid-60s to low-80s percentages for edibles. But the analyst doesn’t expect this to happen before 2021 at the earliest.

For now, says Chu, Canopy Growth stock is a “hold.”

To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.


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