Time to Write Off Canopy Growth Stock in the Short Term

Will Healy

Updated Wed, Sep 11, 2019, 6:15 PM

It goes without saying that Canopy Growth (NYSE:CGC) has endured a rough summer. Market leadership could not compensate for falling multiples, earnings and revenue misses, and a CEO firing. Canopy Growth has bounced back from near-term lows. Still, it remains too early to tell whether that bounce represents a pause in the decline or a genuine turnaround. Until investors can get a clear direction on CGC stock, I recommend staying away for now.

Keep an Eye on Canopy Growth Stock, but Don't Buy It Just Yet

Investors Should Prepare for a Fall

Canopy Growth, and the marijuana industry overall, wants to put this summer behind them. Since the end of April, CGC stock has lost nearly half of its value. Differences with investor Constellation Brands (NYSE:STZ) cost CEO Bruce Linton his job. Moreover, a massive revenue and earnings miss for the second quarter only added to the pain.

Unfortunately, the fall could bring a further fall. The price of dried cannabis has failed to gain traction as inventories rise. Further, the cash position of CGC continues to fall as it fell by 36% over the previous two quarters.

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Furthermore, despite the decline, CGC remains expensive. It currently trades at about 37.2 times sales. In the recent past, such a multiple did not phase investors. However, we have dealt with a market where peers such as Aurora Cannabis (NYSE:ACB), Tilray (NASDAQ:TLRY), and Cronos Group (NASDAQ:CRON) have also seen their stocks drop.

Moreover, the profit picture looks increasingly bleak. For the next fiscal year, analysts had predicted a profit of 31 Canadian cents (24 cents) per share 90 days ago. Now, that estimate has become a loss of 75 Canadian cents per share. That will place further pressure on its cash and could lead to more debt or more stock issuance in a climate of falling prices.

Don’t Bet on Quick Legalization

So what would revive Canopy Growth stock? InvestorPlace contributor Will Ashworth argued that Trump legalizing weed across the country would boost both his re-election chances and CGC.

I happen to agree in principle. I also like that CGC positioned itself to jump into the U.S. with the Acreage Holdings (OTCMKTS:ACRGF) purchase once weed becomes legalized. However, we have to operate in the environment we have, not the one we want. Hence, I do not recommend investing based on that piece unless the political winds change direction. While sudden legalization, especially in the U.S., would help Canopy Growth, investors should instead assume legal status comes to the developed world at a slower pace.

How Should I Trade CGC?

In my view, investors should exit their positions in CGC for now. In the near term, the industry probably faces multiple compression. Investors should not expect the market to grant Canopy Growth stock any type of immunity. Even though fall will arrive soon, investors need to prepare for winter and probably a more permanent climate of lower valuations.

Still, once the market stops selling off CGC, I see the equity as a lucrative long-term investment. First, I believe this industry downturn will ultimately benefit CGC stock. Countries across the world continue to march toward legalization.

Canada’s strict regulatory structure on the marijuana industry has generally not done its companies any favors. However, they helped hugely by seeing the trend toward legalization early and moving first to embrace it. Now, Canopy Growth can use its dominant position in Canada to achieve early mover status in places such as Europe. This process will only speed up should the U.S. move toward legal status more quickly than anticipated.

Moreover, the downturn will lead to an industry shakeout. In this downturn, the more financially-troubled firms will have to sell out to larger firms such as Canopy Growth, in many cases on the cheap. Others will simply close their doors. Either way, over the next few years, CGC will face much fewer competitors at home.

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Canopy Growth stock has become dead money in the near term. However, once it endures a harsh winter, I think it will spring forward to massive long-term gains.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.