May 17, 2021
[8 min Read]
Marijuana, a term that not-so-long ago was strongly associated with drugs and crime, is not possibly one of the most progressive industries in the market. Whether it is for medical or recreational use, marijuana has now become more integrated into society, it is also becoming a common consumer across North America. Related technology and business branches are also developing as legalization initiatives continue. Trading on both the TSX (as WEED) and the NasdaqGS (as CGC), Canopy Growth Corporation is one of the more well-known marijuana companies who as been riding this new tide for awhile now. So, is the growth of this new industry sustainable? If so, is Canopy Growth the ideal investment candidate to capitalize on this development?
Previously known as Tweed Marijuana Inc., Canopy Growth Corporation (TSX: WEED) is a full-scale company, covering most of the vertical channels for their products. They are a producer, distributor, as well as retailer of both recreational and medical cannabis products. Its two main operation segments are consumer products revolving around cannabis & hemp, and “Canopy Rivers”. The company sells consumer products under several brands including Tweed, Quatreau, etc., while also developing a platform for cannabis sector related investments. On the medical front, Canopy has a partnership with NEEKA Health Canada and NHL Alumni Association, researching the impacts of CBD-based treatment for post-concussion symptoms.
From a financial performance perspective, the company has some consistent top-line growth over the years, with a 126.9% 5-year CAGR as off Dec. 31st of 2020. Canopy recorded $506.10M total revenue LTM with a 23.3% gross margin. However, the company is still failing to turn a profit, recording ($598.40), ($745.40) and ($2348) in EBITDA, EBIT, and Net Income respectively. The companies operating margins are also quite inconsistent, with EBITDA margins ranging from 7.3% - (250.6%) since FY2015.
Capital Structure & Shareholders Breakdown
A quick look at Canopy Growth's capital structure: 15.2% Debt, 78.1% Equity. Despite its yearly net losses, the company has still been able to keep a very low leverage on its capital structure. This means there are no additional interest and principal fees that will be paid in the future, which would have further reduced the profitability.
Looking at WEED's shareholders breakdown, we are seeing public & other investors making up most of its outstanding shares at 59.27% of their entire market cap. Public company ownership is at second with 27.29%. However, the public ownership comes solely from its strategic partner Constellation Brands, an alcohol distribution/wholesale & retail company in the US. The two companies have been working towards exploring cannabis-infused alcohol drinks. The significant difference between institution holding (12.41%) and public shareholders means the stock price will be very volatile on the public's perception of the company.
Market & Industry Trends
From my perspective, there is no real valuation that can be applied to the cannabis companies on the public market. It is still a very young industry with a lot of the players who, although had IPOs, are still realistically in the PE/VC stages of their company life cycle. Therefore, analyzing the macro market and industry trends will be the main analysis for these companies, as they are indeed heavily influenced by the market.
Legalization and Political Influences
As expected, the legalization of both medical and recreational cannabis will have a tremendous impact on the public outlook of the related companies, which in turn affects the stock's prices due to the large percentage of public shareholders.
The most recent display of legalization's impact on WEED and other cannabis stocks can be seen on Figure 2.1. On the first purple marker is around late January of 2021, when stock prices really began to soar on the hope that as Joe Biden takes office, there would be more leniency with cannabis legalization. The anticipation was matched with the news that the President was reviewing and pushing for cannabis-related bills. However, when the proposal was rejected, prices immediately began to crash. This shows just how volatile WEED price is when it comes to political influences. Although as investors when can predict that cannabis-related political news would heavily impact the stock, it is unlikely to predict which way the prices will go, and whether or not the outcome will be in favour of the company.
Growth in Cannabis Industry & Increased Accessibility
The overall growth of the cannabis industry increases the accessibility of marijuana related products. As retail locations and pricing become more competitive but stable as the new players comes into the market, demand and sales will continue to increase. Although there is still great demand in the illegal (“plug” formed) markets, increased accessibility and competitive pricing in the legal retails will harbour the growth of the industry. As seen in Figure 2.2, consistent month-over-month growth demonstrates consistent demand throughout the year and increased purchases from legal sources.
Medical Marijuana Market
Although medical marijuana has long been a popular topic in the market, we can see from figure 2.3 that most patents and market is controlled by biopharma and other medical-related institutions. Due to its relation to health and medicine, there is a large amount of regulation and scientific knowledge that creates a high barrier of entry for businesses. As of now, one of the more reliable ways to break into the medical marijuana market is by partnering up with existing players in the industry like what Canopy Growth is doing.
Recreational Marijuana and Consumer Goods
Although cannabis is only a budding industry, it already has a deep product mix. The flexibility of cannabis - in buds, extracted oil, etc. - is one reason why it has been a growing consumer product in society. Although there is a diverse set of offerings, we are still not seeing any dominant or at least leading brands in the market like how Pepsi and Coca Cola dominates the soft-drinks industry. This means the industry will likely consolidate down the road, seeing a few brands grow into market leaders. However, the fact that a number of companies have gone public without a truly reputable product in the market is concerning.
Financials and Valuations
When it comes to the fair valuation of Canopy Growth (WEED.TO), I did not use an intrinsic method through building a Discounted-Cash-Flow model. This is because the large-scale changes in the company's financials and unknown market factors (such as legalization) makes it very difficult to forecast future earnings. Instead, I evaluated the company using a basic comparable analysis. The companies included in the comparable universe are:
As we can see in Figure 3.1, it is not only Canopy Growth, but the overall industry - with few medical cannabis-oriented companies - have negative earnings that are inconsistent and unpredictable. This leads to basically irrelevant trading multiples as we can see above. Negative average EBITDA multiples is very rare and is not usable when converting to implied prices. These figures seem like those of start-up companies who are still very much in the development stage, far away from IPO-ready. The fact that these companies are public are mainly due to the “hype” that has been building up as legalization initiatives continue. They have a very long-term outlook as most of these companies are realistically still in the VC/PE buy-and-grow stages. Nevertheless, I calculated the implied price, which unsurprisingly based on the comparative averages, came out negative:
WEED is a heavily industry-dependent company, catalysts will play a huge part in the stock's performance:
• Acquisition of Supreme Cannabis
In April of 2021, Canopy Growth and Supreme Cannabis entered into a definitive arrangement for a complete acquisition. The deal is valued around $435M based on a fully-diluted equity value, as Canopy is to purchase all of Supreme's outstanding common shares. This deal further demonstrates how realistically, these companies are not ready for the public market. However, with the newly acquired resources and brands, WEED could further develop their revenue streams and operations. Although this deal seems to benefit WEED, the stock continued its plunge after the announcement. This again demonstrates how the stock's performance has little connection to the actual value of the company. Nevertheless, this is a step in the direction, which could eventually contribute to the profit margins and stabilization of the Canopy's operations.
• Partnership & Investment of Constellation Brands
As mentioned above, Constellation Brands (STZ) holds a good portion of WEED's shares and the two companies are working together to explore cannabis-infused alcoholic drinks. This is very interesting as the cannabis industry is known for its diverse offerings, with alcohol being a commonly target direction of expansion. So far, there is no real existing cannabis-alcohol brand in the market, but the demand definitely exists. It will be interesting to watch how this partnership develops. Since STZ is a large importer/exporter as well, it could also potentially help Canopy's scale internationally.
• Legalization on the International Stage
The last catalyst is quite simple: more legalization means more growth potential. Although cannabis is legal in Canada, there are still many untapped markets in the US and parts of Europe that will become available once legalized. The stock will perform according to news and actions taken by governments on the marijuana-legalization situation.
In the end, my thoughts on Canopy Growth Corporation is: I don't know. This is a developing company amongst young peers in a new industry. There are simply no reliable data to properly evaluate the company. The most that could be done is a very macro-outlook on the industry as a whole. In that sense, I think the demand in the cannabis industry is very solid with great growth potentials. Although the legalization problem creates hard barriers for the future of the industry, I believe there are still plenty opportunities in the existing markets. However, from a company perspective, it is very hard to predict what is going to happen to the stock's performance. We can identify the influencing factors such as cannabis-related legal bills and acts, but the large majority of us has no access to inside information that could help us predict the outcome of those initiatives. In addition, most of the companies are realistically in the PE growth stage. They are focusing on branding and creating market-leading products; things that should have been finished before the IPOs. Overall, I think despite the high-growth potentials and demand, Canopy Growth Corporation - and potentially the large majority of the industry - is not ready for the public market, making them very risky investments.
Bull Case: Legalization increases, driving market activities and companies finally obtain consistent revenue/income trends. This will lead to stock price growths.
Bear Case: Legalization progress is limited. This will set hard barriers to the growth of the industry, which means companies will have higher competition for less market size. It will be reflected in decreases in stock prices with the potential exception of a few dominant leaders.