Canopy Growth Corp. (TSX:CGC) has chalked up big gains in 2016, but investors should be careful holding this stock heading into next year.
What’s the concern?
Canopy’s surge in value is primarily tied to investor belief that the Canadian government will create a legal market for the sale of recreational marijuana by the end of next year.
The Liberals laid out this timeline in the spring of 2016 and recently received an in-depth report from the task force set up to study how the government should proceed with the legalization process.
The current schedule would have the government table legislation in the spring and potentially open the market in early 2018. On the surface, that seems plausible, but there are a number of roadblocks that could emerge in the coming months.
Taxation is going to be a big part of the discussion. If legal marijuana sales are taxed too heavily, the black market will thrive, and the whole endeavour could eventually fail.
Conversely, the product has to bring in enough tax to justify opening the market. Otherwise, it isn’t worth going through the process from the point of view of the government.
Tax sharing also has to be sorted out. The provinces will likely be responsible for regulating their respective markets, so they will want to get a hefty cut from the tax revenue.
Whether or not those details can be ironed out in the next 12 months is yet to be seen.
Everyone assumes that Canadians are all in favour of legalizing the sale of recreational marijuana, but there is evidence that local residents might not be too keen on seeing retail outlets popping up in their communities.
For example, Ottawa’s police force recently shut down a number of illegal, but very public, dispensaries after residents raised serious concerns about the impact the stores were having on the local community.
If this sentiment is repeated across the country, MPs are going to get nervous, and that could force the government to kick the can down the road until after the next election.
The fentanyl crisis is another situation to watch carefully.
Daily reports of drug overdose deaths are hitting the front pages of Canadian papers, and the provinces are putting heavy pressure on Ottawa to ramp up its efforts to battle the current opioid crisis.
Not all drugs are the same, but the public might start to wonder why the federal government is working so hard to legalize the sale of marijuana at a time when the country is struggling to cope with the fentanyl problem.
In the eyes of tax-paying Canadians, especially parents, this might seem odd.
If the market starts to sense the government is going to drag its feet on the legalization process, Canopy’s stock would likely come under pressure.
At the time of writing, Canopy’s stock is back down to $8.80 per share, which puts the market capitalization at roughly $975 million. This is still extremely expensive for a business that has quarterly revenue of less than $10 million.
When should you buy?
Canopy is doing all the right things at this point in the cannabis market’s evolution. The company is making strategic acquisitions and is currently the dominant player in the medical marijuana space. If the stock traded at a level solely based on the growth outlook for that segment, the name might be worth owning.
At the moment, however, the valuation is simply too high, so investors should probably stay on the sidelines until the share price returns back to much lower levels or the government gives a firm launch date for the opening of the recreational market.
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Fool contributor Andrew Walker has no position in any stocks mentioned.