Can Canopy Growth's Stock Price Recover To $10?

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Canopy Growth (NASDAQ:CGC), once known as the top cannabis stock to own, has seen its stock drop to levels that it was trading at before it ever achieved the hype it did in 2018. Some of that decline has come in sympathy alongside the overall falling stock prices of the cannabis sector, but much of that decline is self-inflicted, as the company has been unable to control cash flow losses and still is far from profitability. The stock looks buyable here, though one must wonder if it is worth buying at all considering the better opportunities south of the border in the United States.

CGC Stock Price

CGC became the most well known cannabis stock in 2018 when it became clear that Canada was going to legalize cannabis for recreational use. CNBC pundit Jim Cramer said the stock was too cheap at $49 per share. My point is not to pick on Cramer – at the time, the sector was very new and investors held much promise for the name. The stock now trades 90% lower than it did at its peak in 2018.

Data by YCharts

CGC is an example of how the promise of growth can command a higher valuation multiple than the actual growth. Wall Street had high hopes for the stock, but the poor financial performance has sent investors running for the hills. I last covered the stock in November of last year, when I rated the stock as buyable though noted that there are better opportunities in the United States. The stock has since fallen over 50% and my view remains the same: while the stock looks cheap enough to buy, I continue to prefer the stronger opportunities in the United States.

CGC Stock Key Metrics

In the latest quarter, CGC was unable to grow revenue year over year and also saw its adjusted gross margin dip to 13%. The company managed to burn through $168.3 million in free cash flow – more than all of its generated revenue.

Canopy Growth FY22 Q3 Presentation

We can see below that CGC saw weakness in its cannabis business segments, with net revenue declining 20% globally. CGC was able to make up for those declines with 19% growth in its “other consumer products” divisions, which includes segments like its BioSteel beverage products.

Canopy Growth FY22 Q3 Presentation

It’s important to note that CGC does not appear to be a strong cannabis operator. On the analyst call, management basically confirmed that it was realizing negative gross margins on cannabis sales. This is in contrast with Tilray (TLRY), which also has a substantial amount of non-cannabis sales but in that case the cannabis gross margins are higher. The irony here is that undoubtedly every investor is buying CGC for its cannabis operations, but it’d generate stronger financial results without its cannabis operations.

Even on a non-GAAP basis, CGC lost $67.4 million which was in line with the prior year.

Canopy Growth FY22 Q3 Presentation

In isolation, those kind of losses aren’t catastrophic, but the issue is that CGC has been stringing together these kinds of quarters for many years. CGC has seen its net cash position deteriorate from over $4 billion in 2018 to a net debt position in the latest quarter. CGC ended the year with $1.4 billion of cash versus $1.5 billion of long term debt. CGC does have another $898 million of investments primarily made up of its investment in the US operator TerrAscend (OTCQX:TRSSF).

FY22 Q3 10-Q

The evaporated net cash position does heighten the risk profile here even further because if nothing changes on the cash flow front, then this may quickly become a financial solvency risk.

What Is The Target Price For CGC Stock?

Wall Street analysts are not convinced by the story with an average rating of 2.52.

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The average price target of $9.42 per share represents 69% upside.

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I caution that analysts likely haven’t updated their price targets amidst the broader market volatility. I am doubtful that consensus opinion has turned favorable on the company especially considering the lack of progress on the profitability front.

Why Has Canopy Growth Stock Dropped?

We can see below that as the stock price has fallen, its average price target has also fallen.

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There are many potential reasons why the stock has dropped. All cannabis stocks have been in a downward trend over the past year, as it has become clear that federal legalization in the United States may not happen any time soon. In my view though, CGC’s fall has more to do with deteriorating investor sentiment. Many investors were buying this name prior to Canadian cannabis sales coming online. Investors previously were willing to look the other way in regards to the company’s steep operating losses given the attractive secular growth story of cannabis. But with United States peers generating robust profit margins, and even Canadian peers like TLRY generating superior margins, it is understandable for investors to have grown impatient waiting for the fundamentals to improve at CGC. Three years ago, it may have been forgivable to invest in CGC on the basis of promise, but now with many years of actual operating results, it is no longer easy to expect the same dominance that was projected before.

Can Canopy Growth Stock Rebound To $10?

That isn’t to say that CGC can’t deliver strong returns anyway. CGC traded well above $10 as recently as last year. Further, with institutional investments largely blocked out of investing in the stocks of US cannabis operators due to cannabis remaining illegal on the federal level, CGC ironically stands to be a beneficiary upon any hype generation regarding federal legalization. While there are arguably better investment opportunities even among just Canadian operators, the saying “a rising tide lifts all boats” will likely remain true here.

Is CGC Stock A Buy, Sell, or Hold?

In comparison with earlier years, the case to buy CGC is now much harder than before. The company still maintains top market share in the very specific category of Canadian premium flower.

Canopy Growth FY22 Q3 Presentation

However, as discussed earlier, the company is generating poor gross margins from its cannabis operations even after operating for many years – raising questions as to whether the company is a strong cannabis operator at all.

In comparison with Canadian peers, the company has a more built-out footprint in the United States through its investments in the aforementioned TRSSF, as well as its agreement to acquire US operator Acreage (OTCQX:ACRHF) and edibles company Wana Brands upon legalization.

Canopy Growth FY22 Q3 Presentation

That might make CGC a better investment as compared to Canadian peers, but one must wonder if it is better to just invest directly in US cannabis stocks themselves?

CGC is expected to eventually sustain strong revenue growth, peaking at 28% in the year ending March 2025.

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That growth trajectory makes sense. The Canadian legal market has historically been challenged by the illicit market, largely due to the insufficient number of legal dispensaries. Because CGC is largely a wholesaler in the country, it benefits from an increasing number of dispensaries, as customers may be more willing to purchase from legal sources if they had easier access to legal dispensaries. Ontario is the largest province by population in the country by far at just under 15 million. The number of dispensaries in the province has been increasing steadily and totaled over 1300 as of April 2022. Based on the Ontario Cannabis Store Quarterly Review, that is up significantly from just 110 stores at the start of 2020 and the average distance to a store has decreased from 19 kilometers down to just 4.2 kilometers. The improved dynamics may lead to competitiveness at the retail level, but longer term may enable CGC to take greater overall market share from the illicit market.

According to the Canadian Government, only 17% of Canadian adults use cannabis on a monthly basis and 25% have used it in the past 12 months. Compare that to the 78% of adults who have used alcohol in the past 12 months. Over the long term, I expect cannabis use to rival if not exceed that of alcohol use due to its wide range of medical and recreational applications. That should provide long term growth tailwinds which may eventually be able to support higher profit margins. To give an idea of how cheap this stock can prove to be, let’s assume that the company achieves just 15% net margins over the long term. At 3x 2024e sales, the stock is trading at around 20x 2024e earnings power. I could see CGC trading at 2x my projected 20% long term growth rate, suggesting 100% upside from current levels just from multiple expansion alone. In a prior article I suggested a potential future valuation of $1.1 billion for the TRSSF stake (assuming a $20 per share TRSSF stock price). That stake would represent around 50% of the current CGC market cap, suggesting further upside.

Those arguments make CGC look very buyable here at just 4x annualized sales, albeit risky due to the ongoing cash burn. It is highly likely that shareholders will be heavily diluted as the company needs to fund ongoing losses somehow. But more importantly, the long term growth story applies equally to the stocks of US operators, many of which boast strong EBITDA margins and even GAAP profitability. We can see below that CGC trades more expensively on a growth-adjusted basis than US stocks like Curaleaf (OTCPK:CURLF), Green Thumb (OTCQX:GTBIF), Trulieve (OTCQX:TCNNF), and Cresco Labs (OTCQX:CRLBF).

Cannabis Growth Portfolio Research

Unlike CGC which is generating 13% gross margins and burning through cash, stocks like TCNNF are generating 40% EBITDA margins while also posting positive GAAP net income. What’s more, while CGC provides indirect exposure to the US cannabis opportunity through its investments in TRSSF and others, stocks like TCNNF offer direct exposure to the US cannabis opportunity. While I find CGC buyable here, that rating is moreso based on whether the reader is constrained to only invest in Canadian cannabis and is restricted from investing in United States alternatives.