Pardon the pun, but the marijuana industry is growing like a weed, and marijuana stocks are following suit. In many instances, the largest pot stocks by market cap have seen their share prices rise by at least 100% over the trailing year, as investors chase the expectation of broadening legalization efforts throughout North America.
In many ways, these investors haven't been disappointed. Since the year began, Mexico wound up legalizing medical cannabis, Prime Minister Justin Trudeau in Canada introduced a bill that would legalize recreational weed throughout the country by July 1, 2018, and in the U.S. we're up to 29 medical cannabis-legal states and eight adult-use states. The result, according to cannabis research firm ArcView, was 34% legal sales growth in North America last year, and the expectation of a compound annual growth rate in legal pot of 26% through 2021.
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The downside of investing in pot stocks is that it's still an illicit substance in all three countries, at least for now. This limits the ceiling on marijuana's growth prospects, and it also leads to exceptionally high volatility for pot stocks as a whole. After all, there is no guarantee that the marijuana business model has staying power.
This pot stock dazzled last week
Last week, however, volatility proved to be a positive for one pot stock, Canopy Growth Corp. (CGC -0.67%), which managed to tack on an 11% gain for the week. Already the second largest marijuana stock by market cap, Canopy Growth saw its $0.85-per-share gain add $143 million in market cap.
Why the run higher in Canopy Growth Corp.? Part of the reason could be the expectation that Canada will legalize recreational pot come next summer. If we look at the publicly traded medical-cannabis companies operating in Canada, we see they were all up strongly last week.
Interestingly enough, though, the buzz last week primarily revolved around Ontario's decision to allow its liquor control board to oversee 150 brick-and-mortar stores in the province that'll sell cannabis products. Canopy Growth, among other private-sector growers, suggested that it should still have a place in the Ontario market, setting up a potential brouhaha between Ontario and private growers. For what it's worth, Canopy Growth has revamped its e-commerce options in advance of Canada's expected legalization, creating what it believes is an Amazon.com-styled website for weed.
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Then again, press releases may also have had a lot to do with Canopy Growth's impressive performance. On Thursday, Sept. 14, the company announced that it had sold a non-core asset from its wholly owned subsidiary Mettrum Health, which was acquired in January, for more than $5.7 million ($7 million Canadian). It also entered in a three-year supply agreement with Cannabis Care Canada, the company purchasing Mettrum's asset.
Canopy Growth also announced that it entered into a supply agreement with AusCann Group in Australia, as well as a supply licensing agreement with Alcaliber in Spain via Canopy Growth's wholly owned subsidiary Spektrum Cannabis GmbH. These agreements are nothing new for Canopy Growth, which is among a very small handful of Canadian producers that has a green light to export its dried cannabis to other countries.
Challenges lie ahead for Canopy Growth Corp.
While a lot has clearly gone right for the company, there's still a challenging road ahead that doesn't guarantee success.
For example, don't count on Canadian recreational legalization as a sure thing -- or if it is a sure thing, don't expect that it will roll out smoothly. The Canadian parliament has received pushback from provinces that worry about getting police and regulatory agencies set up in just the next 10 months. More conservative lawmakers among our neighbors to the north are also concerned about minors' access to cannabis via the home-grow option, as well as how driving under the influence will be enforced for pot users. Though marijuana is popular among the public in Canada, it's no sure thing to be legalized.
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Another concern is Health Canada's rollout of the red carpet for more growers. In May, there were fewer than four dozen licensed medical-cannabis growers, but the eligible number of medical patients in Canada was growing by 10% a month. As such, the regulatory body responsible for the health of Canadians decided to loosen regulations and speed the approval process for licensed growers. The result should be a flood of new licensed growers that potentially eat into Canopy Growth's market and adversely affect its margins.
More importantly, can the company live up to a nearly $1.4 billion valuation when it's yet to deliver anything more than nominal quarterly profits? Recently, investments and acquisition-related costs dragged the company into the red for fiscal 2017, but even if we exclude those costs, the company would be valued at a triple-digit P/E. Canopy Growth presumably can't grow annual sales at a triple-digit percentage for too much longer, so it'll need to demonstrate to investors that it can also improve its bottom line.
For the time being, caution remains the name of the game with pot stocks such as Canopy Growth Corp.
