Canopy Growth Corp. (TSX:CGC) has been on a wild ride in recent months, and investors who think the name has long-term potential are trying to decided when they should buy.
Let’s take a look at the current situation to see if this is the right time to add Canopy to your portfolio.
Volatility
Canopy has traded in a range between $5.50 and $17.50 per share in the past three months. To say the stock is volatile is an understatement.
The moves are not unusual for a market leader in a rapidly emerging segment, but they also provide investors with a good snapshot of the risks they are taking by trying to nail down the best price for the stock.
What’s the issue?
Canopy is doing all the right things at this point in the evolution of the marijuana market.
The company is ramping up its production capabilities through partnerships and takeovers and extending its reach into new markets.
Canopy signed an agreement with real estate developer the Goldman Group that will see Goldman acquire or build properties and outfit the facilities according to Canopy’s production specifications. Canopy will then lease the building from Goldman.
The move is a smart one as it reduces the amount of upfront capital Canopy needs to ramp up production capabilities while accelerating the process.
Canopy has also been on an acquisition warpath, snapping up competitors in a move to quickly position itself as the market leader. The deal to buy Mettrum Health Corp. is the most significant as the two companies currently control about half of the medical marijuana market in Canada.
Mettrum also comes with two national brands and important additional production facilities.
Outside the country, Canopy has a partnership in Brazil and recently purchased a pharmaceutical distributor in Germany.
So, from the point of view of market dominance and strong management, the company looks like a strong buy.
Valuation
Canopy’s stock has soared on the hopes that Canada will implement a legal recreational cannabis market in 2018.
The government has already received a preliminary report from its task force and is expected to table legislation in the spring. If all goes according to plan, the market could be open at this time next year.
Canopy is the market leader in the cannabis space, so it would be reasonable to assume the company will get a big chunk of a recreational market that pundits believe could be worth at least $5 billion per year.
This is why investors have pushed up the company’s valuation to nosebleed levels. At the current price of $9.72 per share, Canopy has a valuation of $1.2 billion.
Here’s the concern.
Canopy’s Q3 2016 sales came in at less than $10 million and the company still isn’t profitable. So, the current price in no way reflects the value of the medical marijuana business, and is purely based on speculation that the recreational market is coming soon.
Is that reasonable?
The government could very well hit its schedule, but investors should be careful.
Tiny Uruguay, which is about one-tenth the size of Quebec, took five years to finally hammer out the details on its legal marijuana market, so it wouldn’t be a surprise if Canada takes a bit longer than expected to make sure things are set up properly.
Any hint of delays or backtracking would likely send investors running for the exits. In that scenario, Canopy could get crushed.
When should you buy?
Based on the level of uncertainty and the extreme valuation, the current price is probably not a low-risk entry point for this stock. In fact, I would avoid the name altogether.
Investors with a larger risk tolerance should at least wait for the next big downdraft before buying Canopy.
