ACRDF - Canopy Growth Is Not A Good Stock For Cannabis Investors

Summary

• I have followed Canopy Growth since it went public in 2014.
• Investors seemingly care about this company too much.
• In my opinion, the U.S. strategy shift will either fail or won't make a difference.
• The stock, which could fall close to 50% in my view, isn't likely to do as well as peers even if it succeeds in closing the 3 American acquisitions.

Canopy Growth (CGC) is one of the most popular cannabis stocks. At Seeking Alpha, it has over 140K followers. The largest American cannabis company by revenue or market cap, Curaleaf (CURLF), has just under 25K followers. An earlier go-public date is part of this, but the real impediment, in my view, for American companies is their listing on the OTC instead of a higher exchange. Canopy Growth also trades a lot of shares each day. The 30-day average of 9.6 million shares per day on the NASDAQ, for example, is a lot higher than the 456K at Curaleaf, even adjusting for the slightly higher price at Curaleaf.

Despite being so popular with investors, the stock has had horrible performance. Since the end of 2021, it has dropped 70.1%. Since the peak in early 2021, it has declined by 94.6%. The New Cannabis Ventures Global Cannabis Stock Index has declined from its close on 2/10/21 of 92.48 by 88.6%.

In this review, I discuss the valuation, which seems high to me, and its operations, which haven't been productive. I also look into a potential change ahead, which would have the company closing on three acquisitions in the U.S., and assess how that could play out.

Canopy Growth Fundamentals

The company has a fiscal year that ends in March, and it has scheduled its Q3 release for February 9th. In Q2, it was expected to generate total revenue of C$122 million with adjusted EBITDA of -C$62 million. The actual results showed revenue fell 10% from a year ago to C$118 million. Adjusted EBITDA of -C$78 million was significantly worse than expected.

Looking at the details revealed that BioSteel, an investment of theirs that has nothing to do with cannabis, provided a lot of growth, gaining 299% to C$29.9 million. The rest of the business was very challenged. In adult-use, overall sales fell 35%, despite a growth in Canadian adult-use, to C$38.1 million. Business-to-consumer, which is now gone after a sale, was C$12.8 million. Business-to-business fell 40% from a year ago to C$25.3 million. Canadian medical cannabis rose 8% to C$14.2 million. International sales fell 55% to C$10.6 million due to the exit from the C3 business (C$11.9 million in the prior year). The non-C3 business fell 9% from a year ago. Ancillary unit Storz & Bickel fell 7% to C$13. 5 million, and This Works declined 24% to C$6.9 million.

For FY23, the company had been expected before its Q2 report to generate revenue of C$475 million and adjusted EBITDA of -C$247 million. Now, after the weak report and divestiture of its Canadian retail stores, the analysts project revenue will decline 10% during the fiscal year to C$468 million with adjusted EBITDA of -C$279 million. FY24 shouldn't be a lot better! Analysts expect revenue will increase 8% to C$505 million with adjusted EBITDA improving but still at a big loss of -C$172 million. Before the report, they had expected revenue of C$667 million with adjusted EBITDA of -C$129 million.

Canopy Growth ended Q2 with a pressured balance sheet. Tangible equity was reported to be C$1.265 billion, including cash and short-term investments totaling C$1.14 billion. Debt, though, was C$1.35 billion. Given the large expected losses ahead, cash will dwindle as will tangible book value.

Canopy Growth Valuation

Canopy Growth trades at about 1.33X its tangible book value, which sounds pretty good, but it is high relative to better large companies in Canada. The company has net debt and loses a lot of cash from its operations. Three stocks that I consider superior are Cronos Group ( CRON ), Organigram ( OGI ) and Village Farms ( VFF ). Cronos Group has a large amount of net cash and trades at 0.82X tangible book value. Organigram, which also has a large amount of net cash, trades at 0.91X tangible book value. Both of these companies have large investors that are tobacco companies that could acquire them. Village Farms, which has a small amount of net debt, trades at 0.65X tangible book value.

Looking at the FY2024 estimates, the stock, with an enterprise value of C$1.88 billion, trades at 3.7X projected revenue. Given the large expected loss in adjusted EBITDA, this is too high in my view. For FY25, analysts currently project -C$84 million adjusted EBITDA with revenue climbing 23% to C$619 million. My target a year from now on the current business is an EV/Sales of 2X. This works out to an enterprise value of C$1.24 billion, which suggests a stock price that would be considerably lower. Based on my projected cash-burn of C$200 million, the market cap would be C$884 million, which is C$1.82. In USD, this would be approximately $1.36, a decline of 48%.

Canopy Growth's Potential Transformation

Canopy Growth has three pending acquisitions, including Acreage Holdings (ACRHF) and two private companies, Wana Brands and Jetty Extracts. Its shareholders must vote to change the corporate structure. The meeting isn't yet scheduled, but Canopy Growth has filed a preliminary proxy statement . The company is trying to pass a special resolution to create "exchangeable shares" that allow it to possibly retain its NASDAQ listing after closing the acquisitions. The proposal was first made on October 25th, and Canopy Growth warned two days later that NASDAQ may not allow it. The company released this deck when it announced the move.

The company indicated the timing of the closures of the deal as April 2023 to September 2023 (H1) for the two private companies, and October 2023 to March 2024 (H2) for Acreage.

One thing that concerns me about the company moving into the U.S. is that it could make it very difficult for Constellation Brands ( STZ ), its large investor that is deeply under water in its investment but could buy them, to actually buy them. The stock trades way below the prices Constellation paid, and I considered that perhaps they might acquire Canopy outright. If Canopy Growth buys American cannabis companies but loses its listing, then Constellation would risk its listing status if it were to buy the company. Of course, if it is able to keep its NASDAQ listing, then perhaps Constellation will likely acquire it. The senior management at Canopy Growth came from Constellation.

I think it's possible that NASDAQ will allow the company to retain its listing after creating this structure, but it also may not. It's not clear what Canopy Growth will do if it is forced to give up the NASDAQ listing. I think that becoming an American MSO structurally will not be helpful to the company if it downgrades its listing status to the OTC.

I think that a situation where Canopy Growth was unique in its listing on the NASDAQ with most of its revenue coming from the U.S. would be good for the stock, but this is very unlikely. If Canopy Growth can get NASDAQ on board, other American operators with higher revenue and adjusted EBITDA will just mimic the structure. Investors wouldn't likely chase Canopy Growth in transition with its M&A and would opt instead for proven operators.

Conclusion

Canopy Growth has been around for a long time. In fact, this year will mark the 10th anniversary of its formation and the 9th of its going public in Canada (in April 2014). The stock is very popular with investors, and I think its current plan is a no-win situation for the company. If it is able to succeed in keeping its NASDAQ listing but migrating its business to the U.S. by closing the acquisitions, its American peers will pursue the exchangeable shares strategy too. If it isn't successful, then investors are stuck with a poorly performing company at a relatively high valuation. I see so many better opportunities in the cannabis market than Canopy Growth, which I project will decline by 48% with its current structure.

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