Like most pot stocks, Canopy Growth Corporation (CGC 2.41%) saw its shares reverse course in a big way last week. The Canadian pot titan, for instance, shed a whopping 17.4% of its value over the last five trading sessions. As a result, Canopy's stock is now trading well below its 52-week highs -- an odd occurrence for a stock that hit its high-water mark for the year only two weeks ago.
What's going wrong for Canopy and other pot stocks? Although the exact cause is unknown, the most likely culprit is a wave of profit-taking hitting the industry. Canopy and its peers like Tilray and Cronos Group have been ripping higher this year, thanks to the end of prohibition on recreational marijuana in Canada earlier this month. Now that these companies have to start justifying their premium valuations in the form of sales, however, early bird investors appear to be hitting the exits.
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Does this double-digit pullback in Canopy's stock represent an attractive entry point for long-term investors, or should investors remain cautious with this name for the time being? Let's take a look to find out.
The positives
Canopy has several key advantages over competitors like Cronos and Tilray. First and foremost, Canopy has the largest production capacity among Canadian pot companies right now and it's not even a close race. According to a recent investor presentation, for example, Canopy has already begun work to reach a total of 5.6 million square feet of growing space.
That amount easily trumps the growing space of the next eight largest Canadian cannabis companies. To be fair, though, Tilray does have a plan laid out to dramatically boost its own production capacity, which should help to close the gap with Canopy within the next year or so. But the point still stands. Canopy is, by far, the country's largest cannabis producer and this competitive advantage won't evaporate overnight.
In addition, Canopy has an impressive eight distribution agreements in place with various Canadian provinces, and a growing commercial presence with both brick-and-mortar stores and online portals, where customers can order from the friendly confines of their homes.
Keeping with this theme, Canopy has already extended its operations beyond Canada in countries such as Australia, Germany, and the Czech Republic. As the commercial opportunity in Canada is somewhat limited due to the country's fairly small population, international expansion is going to be key in terms of future growth.
Last but certainly not least, Canopy became the first cannabis company to attract the attention of a major beverage maker earlier this year. Constellation Brands (STZ -0.64%), a leading alcoholic beverage company, recently plowed an eye-popping $4 billion into Canopy through a strategic partnership. This deal immediately transformed Canopy into the best-financed cannabis company in Canada by a country mile.
Apart from this sizable cash infusion, this partnership also has the potential for Constellation to end up owning more than half of Canopy -- that is, if Constellation decides to exercise its remaining warrants. Constellation thus appears to be boxing out potential competitors in the event that it chooses to buy Canopy lock, stock, and barrel.
The negatives
The so-called green rush that's caused valuations across the industry to soar this year has its fair share of skeptics, and for good reason. In short, cannabis companies, for the most part, are trading on rampant speculation, rather than on their underlying fundamentals. And Canopy isn't immune to this trend. Even after last week's pullback, for instance, Canopy's stock is still trading at roughly 13 times its projected 2019 sales.
To put Canopy's present valuation into the proper context, biopharma stocks are often considered expensive when they hit five times their forward-looking sales. And biopharma companies are well-known to sport some of the richest valuations in the entire market. So, Canopy and its fellow cannabis brethren are clearly garnering massive premiums right now -- premiums that may not be justified in the short term.
The long and short of it is that other G7 countries may not be so quick to end cannabis prohibition. And this slow march toward broader legalization could seriously harm Canadian pot pioneers like Canopy. The United States and European markets, after all, are estimated to be over 10 times as large as Canada's legal marijuana industry. Moreover, there is a glut of companies in Canada vying for a limited market.
The verdict
Is Canopy's stock worth buying on this dip? For conservative-minded value investors, the answer is obviously no. And even aggressive growth-oriented folks may want to think twice. Canopy is probably going to end up being one of the few companies to actually survive the growing pains associated with the decriminalization of pot across the globe, but its stock is simply too expensive right now.
But investors keen on owning a piece of the marijuana pie may want to buy Constellation's stock instead. Constellation's stock is far cheaper than Canopy's, based on its forward-looking price-to-sales ratio of 4.45. Moreover, the beverage maker has a well-established business that continues to grow, and it offers a modest dividend yield of 1.4% to boot.
And by buying Constellation, you are, in effect, buying Canopy by proxy. After all, Constellation is probably going to end up acquiring Canopy if the cannabis industry does live up to expectations. But this route is arguably much less risky than owning Canopy's stock directly.
