MENU

Canopy Growth Corp.: Can Investors Rely on Ottawa to Deliver?

Photo: Plantlady223. Licence: https://creativecommons.org/licenses/by-sa/4.0/ Source: https://commons.wikimedia.org/wiki/File:Young_cannabis_plant_in_the_vegetative_stage_01.jpg

Canopy Growth Corp. (TSX:WEED) is riding a wave of sky-high investor expectations.

Let’s see if the market might be getting ahead of itself.

Leading the charge

Canopy is the leader in the burgeoning market for medical marijuana in Canada, and recent developments suggest it is positioned well to maintain its stronghold in the sector.

Why?

The company is moving at a rapid pace to cement its position through organic growth, strategic partnerships, and targeted acquisitions.

Canopy recently closed its acquisition of Mettrum Health Corp., which adds two national medical marijuana brands and brings significant additional production space. Combined, the two companies supply about half the current market.

Management also just finalized the purchase of the property that houses its corporate headquarters and the Tweed Inc. production facilities. The deal nearly triples the available production space at the site and provides the footprint the company needs as it looks to expand into additional processing activities.

In order to fast-track the development of its production capabilities, Canopy has entered an agreement with the Goldman Group where Goldman will acquire or construct facilities and set them up according to Canopy’s specific production requirements.

Canopy will then lease the sites from Goldman.

Management has done a good job of tapping the market for additional funds through a series of well-timed equity sales. The last issue raised $60 million at $10.60 per share.

Canopy currently trades for close to $12, so everyone involved is probably happy with the deal right now.

What about the recreational market?

Canopy is making all the right moves, but the company’s $1.5 billion market capitalization isn’t justifiable based on the medical marijuana business as it currently stands.

Why?

Canopy’s revenue for the quarter that ended September 30, 2016 was just $8.5 million, and while sales are rising, the valuation is still at nosebleed levels.

What’s going on?

Investors are betting that Ottawa will legalize the sale of recreational marijuana sometime next year.

With an estimated market size of at least $5 billion, it’s easy to see why people are getting excited, but the optimism might be a bit unrealistic.

The government received its task force report late last year and is expected to table legislation in the spring. That might happen, but there are a number of potential speed bumps that could slow down the process.

For example, Ottawa will have to iron out a tax plan that brings in enough cash to justify legalizing the market, but that also keeps prices low enough to entice Canadians to buy legal pot. The provinces will want their cut too, as they will likely be the ones responsible for managing the roll-out in their own backyards.

Negotiations between Ottawa and the provinces are rarely concluded quickly, so it’s possible the tax issue could cause delays.

Public opinion is another potential sticking point. Canadians might be pretty relaxed about the idea of letting people smoke legal marijuana, but that doesn’t mean they want dispensaries popping up in their neighborhoods.

In fact, police have already had to raid and shut down a number of illegal, but very public, locations in Ottawa as a result of resident complaints.

If MPs start to get an earful from concerned constituents, the whole roll-out might come to an abrupt halt.

Should you own Canopy?

The company is making all the right moves, but the stock price appears to be pricing in significant upside from the launch of the recreational market, and I’m not convinced things will happen as fast as investors hope.

As a result, I would avoid the stock today.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Adviser Iain Butler and his team at Stock Advisor Canada are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Click here to find out how you can get instant access!

Fool contributor Andrew Walker has no position in any stocks mentioned.

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.