Canadian cannabis stocks have gained momentum in recent trading sessions on the possibility that the U.S. government might decriminalize marijuana, eventually leading to the legalization of pot at the federal level. Shares of Canopy Growth (TSX:WEED) have surged over 40% in the last three months, valuing the company at a market cap of $551 million.
Despite these outsized gains, WEED stock is trading 99% below all-time highs and has burnt massive wealth for its shareholders. Let’s see if Canopy Growth stock is a good buy at its current valuation.
The Canadian cannabis market is broken
Canada legalized cannabis five years ago, and this optimism drove shares of Canopy Growth and its peers toward all-time highs. However, investors failed to account for several factors, such as the slow rollout of retail stores in major Canadian provinces, rising competition, and cannibalization from the illegal market.
Moreover, Canopy Growth and its peers invested heavily in acquisitions to gain market share and expand manufacturing capabilities. A majority of these acquisitions were overvalued, resulting in billion-dollar write-downs and significant losses.
Due to aggressive expansions and the entry of new players, the Canadian marijuana market soon wrestled with an oversupply of products, resulting in higher inventory levels. Now, to offload their inventory, several marijuana producers sold products at a loss, leading to unsustainable cash outflows.
To offset these cash-burn rates, cannabis companies had to raise capital by issuing equity, which led to shareholder dilution. In the last two years, Canopy Growth reduced its manufacturing footprint and reduced employee count to improve the bottom line.
Between fiscal 2020 (ended in March) and fiscal 2023, Canopy Growth reported cumulative operating losses of $2.9 billion. In the last 12 months, it has burnt through over $400 million in cash to sustain its operations, which does not include capital expenditures or investments in growth opportunities.
Given the current cash-burn rate, Canopy Growth is not generating any positive cash flows, which suggests it might run out of cash in the next two years. In August, the company emphasized it would need to raise funds to meet its obligations, making investors nervous.
Is Canopy Growth stock a good buy right now?
Investing in Canopy Growth remains a high-risk proposition for shareholders. It reported revenue of $81 million in the fiscal first quarter (Q1) of 2024, which was a decline of 31% compared to its quarterly sales three years back.
Its net losses of $917 million in the last four quarters also suggest Canopy Growth is nowhere close to profitability. Analysts tracking the company expect its adjusted loss per share to narrow from $7.07 in fiscal 2023 to $0.26 per share in fiscal 2025. But given its number of outstanding shares, it suggests Canopy’s adjusted losses in fiscal 2025 will be close to $200 million.
Additionally, even if marijuana is legalized south of the border within the next five years (which seems unlikely), there are several larger domestic cannabis producers with entrenched positions and robust balance sheets that are likely to gain market share.
Bay Street expects WEED stock to gain over 50% in the next 12 months. But Canopy’s risk/reward profile is far from compelling, making it a stock you should avoid in 2023.
