Well, Canopy is admittedly more like $5.86 a share at writing, but that still amounts to an impressive 78% drop from the company’s closing price as of the time of writing.
Canopy Growth Corp. (TSX:WEED)(NYSE:CGC) is perhaps at the pinnacle of the Canadian cannabis industry, and in many ways has paved the way for other smaller players to achieve valuations that have simply skyrocketed in recent years.
I’m a conservative long-term investor and don’t concern myself with the story behind these stocks as much as the fundamentals and numbers. When the numbers don’t add up to the story folks are telling, I like to dive a little deeper.
Here’s the Coles Notes version of my takeaways from Canopy’s financial picture at this point:
- Cash burn (negative free cash flow) of -$1.35B over the past trailing 12 months
- Common stock issuances of $5.23B in the past year needed to fund the company’s cash burn and CapEx budget
- Capital expenditures of $740M in the past year
- Acquisitions/Other investing activities of $1.37B in the past year
- SG&A costs that are 2.5 times higher than revenue
- Revenue growth of “only” 28.5% comparing TTM to past full fiscal year
- Four consecutive massive earnings misses
- Paper profit gains due to inventory valuation difficult moving forward
- 31.7 price-to-sales ratio
Okay, that’s a lot to take in, but here’s my take on what the numbers mean.
Let’s start at the bottom: the company’s 31.7 price/sales ratio is absurd by any stretch of the imagination. Even the most hyped up technology stocks can’t reach this kind of astronomical insanity (mind you, some pot stocks were hitting valuations of 135 times sales in the past, as I’ve touched on before).
In general, a price target of two times sales for a fast-growing stock that has reached maturity can be seen as a realistic long-term target scenario.
Let’s use that as a solid rule of thumb for where Canopy will be in five years as a mature cannabis producer in a mature market that has everything figured out.
Let’s also use the company’s recent revenue growth rate of 28.5% (comparing TTM to past fiscal year, crude I know, but also in my opinion aggressive given the fact that it gets harder and harder to grow at ridiculous percentages over time) to factor in where revenue will be in five years. Taking the company’s TTM revenue of $291M, we get revenues which just cross the $1B plateau in 2024.
Keeping the assumption of a 2 times price-to-sales ratio, we come up with a market valuation somewhere slightly more than $2 billion, translating to a $5.86 price target using the current number of shares outstanding (of course, all this math goes out the window when, not if, the company issues more shares).
Another statistic that’s not on the initial list is the company’s long-term debt obligations, which have surpassed the $1 billion mark. The company is levered to nearly four times its revenue and will need to either add on more debt or sell more shares (diluting shareholders) to keep up with its billion-dollar-plus annual cash burn.
Forget about the absolute glut of inventory in the market and a thriving black market in Canada. These headwinds are not factored into this model, but could be interpreted as being reflected in my ultra-conservative P/S multiple used.
The large variance between my calculations and those of other Bay Street analysts can mostly be attributed to revenue growth rates that I don’t see as realistic.
The Canadian cannabis market is limited, and I’ve touched on why Canopy will have a difficult time truly penetrating global markets in previous analysis.
Here’s another thing to consider: in order to double your money on Canopy in the next five years, and assuming an end state price-to-sales ratio of 2, you’d be factoring in a 100% annual revenue growth rate.
Stay Foolish, my friends.
