Canopy Growth Corp. (TSX:CGC) is a high-profile stock in Canada right now.
Let’s take a look at the medical marijuana juggernaut to see if it deserves to be in your portfolio.
All the right moves
Canopy’s management team is making the necessary moves to secure the company’s leadership position in the burgeoning marijuana market.
The business is expanding its production base in a measured and balanced way through a mix of organic development, partnerships, and acquisitions.
Canopy recently purchased the property that houses the company’s head office and the Tweed Inc. production facilities. The deal gives Canopy enough space to nearly triple its current production and processing capacity.
Canopy is also finalizing its acquisition of Mettrum Health Corp., which brings two national medical marijuana brands and additional production facilities. More importantly, the merger creates a business that controls close to half of the current medical marijuana market in Canada.
Scaling up quickly and efficiently is a key part of Canopy’s strategy. That’s why it entered a partnership arrangement with real estate developer the Goldman Group.
Goldman will purchase or build new facilities and equip them to meet Canopy’s production needs. Canopy will then lease the sites from Goldman.
To pay for the rapid expansion, Canopy has tapped the market in a number of well-timed equity issues. The last offering raised $60 million in a bought deal at $10.60 per share.
At the time of writing, the stock trades for about $10, so the company did well on the deal.
Recreational market
At $10 per share Canopy has a market capitalization of about $1.25 billion. That’s a steep valuation for a company that generated $8.5 million in revenue in the quarter ended September 30, 2016.
What’s going on?
Investors are betting on the launch of a legal recreational market in 2018. Estimates vary, but pundits believe the market could be worth at least $5 billion per year.
The federal government received its initial task force report on the matter at the end of November 2016, and is expected to table legislation in the spring of this year.
If all goes as investors hope, Canadians could be lining up to buy legal pot as early as 12 months from now.
Risks
It’s certainly possible the government will meet that timeline, but investors should consider what will happen if the process hits a few speed bumps.
First, the government has to sort things out with the provinces, both on a tax-sharing basis and on the fine print as to who will be responsible for overseeing the roll-out and subsequent policing of the market.
The tax issue alone could hold things up for some time.
Why?
Charging too much tax will simply drive buyers to the black market, but not taxing enough will defeat the whole purpose of the scheme, in my view, which is to line government coffers. Finding that magic number isn’t going to be easy.
Legalizing pot right now might also turn out to be risky for this first-term government. Canadians are pretty relaxed about the idea of people smoking marijuana, but that doesn’t mean families want their neighbourhoods populated with pot dispensaries.
Residents have already complained about existing illegal stores that have sprouted up in their local communities. In Ottawa, of all places, police had to raid several sites after residents protested. In Toronto, police are struggling with elevated levels of crime at illegal dispensaries, which have become prime robbery targets.
If MPs start to sense their seats could be at risk in the next election, the whole process could come to a screaming halt.
Should you buy Canopy today?
Canopy is a market leader in a growing sector and is positioned well to benefit when the recreational market opens. At this point, however, I think the downside risk to the stock on bad news from Ottawa simply outweighs the potential gains.
As such, I would avoid the name today.
