Oh, how the mighty have fallen.
Shares of Canopy Growth Corp. (TSX:WEED) have dropped by over $6 a share, or 47.5%, since the middle of February. Although the loss in value doesn’t appear to be slowing down, at some point, Canopy will find a new equilibrium.
The problem with companies like Canopy is that investing in them is investing for the future, not for today. Canopy has a market cap of a little over $1 billion and yet, last quarter, it only brought in $10 million in revenue. But the counterargument to this is, when the market becomes much larger, it will bring in far more revenue.
Nevertheless, we’re dealing with an overpriced company that doesn’t follow traditional analysis. It’s based, in large part, on the exuberance of investors. So, what factors are in play for Canopy in the coming years?
The first has to do with regulation. Right now, Canopy serves 50,000 people, or 50% of Canada’s registered patients. This is a good position to be in, but the real play here is in the retail business. That means that Canopy needs Canada to legalize retail marijuana.
Thanks to a bill introduced in April, the expectation is that retail marijuana will be a thing by the middle of 2018. The problem with this bill is that it requires the individual provinces to create their own rules for distribution and sale within their boundaries. That could take much longer, so there remains ambiguity about when the friendly regulation will actually be passed.
Another problem has to do with market share. Currently, Canopy has 50% of the medical marijuana market; however, according to the Canadian government, there are, as of March 31, 414 applications in progress from entities that want to become licensed producers of cannabis for medical purpose. Can Canopy keep its market share with so many potential competitors?
On that topic, Canopy has dealt with competition by acquiring those suppliers. For example, Canopy acquired Mettrum Health last year, which was a big move for the company. The problem is that Canopy has issued equity to pay for the acquisition, so if it keeps doing that to acquire more competitors, it could result in further dilution to current investors.
And finally, there’s supply. Can Canopy even keep up if marijuana legalization happens?
The company currently has an agreement with Goldman Group, a real estate developer that buys and develops growing facilities for Canopy, which then leases the properties. But can Canopy scale its operation quickly enough to be in a place to dominate when regulation gets approved? That’s a big unknown that could eat into market share.
Ultimately, things are going to be tough for Canopy because there are so many unknowns. Legalization could take longer than planned, and even if it’s passed, there’s the problem of supply. And with so many competitors launching, Canopy’s strong market share could get whittled down. I think there is more fat to trim from Canopy, so I wouldn’t buy yet. However, there are so few alternatives to gain exposure to the marijuana industry, so owning shares of this company certainly makes sense. You just need to be patient.
