Marijuana stocks had a tough run in the first year of legal recreational cannabis sales in Canada.
The industry initially struggled with supply shortages and distribution problems when the market launched in Q4 last year. This led to an investor exodus with many of the leading pot stocks tumbling 40-50% in a matter of weeks.
Canopy Growth (TSX:WEED)(NYSE:CGC), for example, traded at $65 per share in the run up to the opening of the recreational marijuana sector but fell back to $36 just before the December holidays. Renewed optimism and a recovery in the broader equity markets in January sent the share price close to the previous high and the positive trend continued through the end of April.
At that point, the wheels fell off the bus once again.
Investors started to reconsider the hefty valuations they were giving the cannabis companies, as it became evident that sales growth wasn’t materializing as expected, while expenses soared. The race to scale up capacity in many international markets at the same time in an effort to secure a foothold ahead of anticipated regulatory changes led to a spending bonanza.
With quarterly reports showing extreme cash burn, valuations began to tumble.
Canopy Growth’s founding CEO and chairman was let go by the board of directors. Analysts say the decision came from Constellation Brands, a U.S. beer and spirits giant, which owns a 38% stake in Canopy Growth through two rounds of investments totalling more than $5 billion.
Constellation Brands initially installed its CFO into the chairman role and recently made him the new CEO. That news provided additional support to the share price. Canopy Growth had fallen below $19 per share in November and has traded as high as $28 in recent days.
At the time of writing, investors can pick up the stock for $27.
That’s still well below the $48 per share Constellation Brands paid in its $5 billion investment in August 2018, so the new boss has some work to do to get his previous company’s investment back to a breakeven level.
Cannabis bulls point to plans for more retail locations in Ontario as a positive sign for the sector in 2020 and in the coming years. The lack of brick-and-mortar shops in Canada’s largest market is blamed for the low sales of recreational cannabis and the related products.
In addition, the impending opening of the edibles and drinks segment should be positive for Canopy Growth. Constellation Brands is developing cannabis-infused beverages with Canopy Growth. The company should benefit from Constellation Brand’s extensive distribution network and expertise in the drinks sector.
Canopy Growth also owns a controlling interest in a leading sports drink company in the United States.
The U.S. is expected to make cannabis sales legal at the federal level. This would open up a massive new market for the industry that is already thriving in states that allow marijuana sales. Canopy Growth has an agreement in place to acquire Acreage Holdings, a major player in the U.S. market, in the event marijuana sales get the federal approval.
Should you buy Canopy Growth?
Canopy Growth still has a market capitalization of $9.4 billion, which is steep for a business that is losing money and facing stalled out revenue growth. In the event the broader stock market takes a nose dive in early 2020, the share price could retest the 2019 low.
However, marijuana bulls might want to take a small contrarian position now or on further weakness. If the global market materializes as predicted, Canopy Growth will likely be a leader and the upside potential for the share price is substantial.
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The Motley Fool recommends Constellation Brands. Fool contributor Andrew Walker has no position in any stock mentioned.
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