Constellation Brands (NYSE:STZ) is best known for its top beer, wine, and spirits brands, including Corona Light, Robert Mondavi, and Svedka Vodka. But it's also a marijuana stock.
The company acquired a 38% stake in Canada's market share-leading cannabis company, Canopy Growth (NASDAQ:CGC), in 2018, and this week it offered some insight into marijuana's potential to justify its $4 billion investment. Here's what Constellation is saying about this emerging industry.
Suds to buds
Globally, consumers spend $150 billion on marijuana, including CA$6 billion in Canada and $50 billion in America. The size of the marijuana market rivals that of tobacco and alcohol, so it's little wonder Constellation Brands was eager to partner with Canada's biggest cannabis company by revenue and market cap.
Initially, Constellation Brands acquired a little less than 10% of Canopy Growth for CA$245 million in November 2017. Encouraged by what it saw, it made a much bigger splash last August, spending CA$5 billion to boost its stake to 38%. It also acquired warrants that allow it to increase its ownership to above 50% for at least CA$4.5 billion, if exercised.
The move positions Constellation Brands to benefit from growing momentum to legalize marijuana worldwide. Canada became the first large, developed country to create a national adult-use recreational market last year, but it's not the only place where people are passing pro-pot laws. Germany and Australia have budding national medical-marijuana markets, and 33 individual U.S. states have passed laws allowing medical marijuana use, including 10 states that have also signed off on recreational adult use.
The shift in cannabis regulation could have a big impact on Constellation Brands' core beer, wine, and spirits business. Alcohol consumption has declined relative to cannabis in jurisdiction with pro-pot laws, according to a 2017 study by investment firm Cowen & Company.
What's marijuana's outlook?
The potential widespread legalization of marijuana is exciting because it could shift over $100 billion in spending out of the shadows. It's not just dried marijuana flower that could take off, though. Canada's cannabis companies are generating substantial revenue from marijuana extracts, including THC and cannabidiol (CBD) oils. THC, the most common chemical cannabinoid in marijuana, is associated with marijuana's psychoactive effects, while CBD, the second most common cannabinoid, is associated with wellness.
The potential to incorporate THC and CBD as ingredients in food and beverages could be worth many billions more to Constellation Brands, Canopy Growth, and its competitors.
At the annual Consumer Analyst Group of New York conference this week, Constellation Brands highlighted the fact that over 30 countries are exploring pro-pot laws. If all of them legalize marijuana, it would create a market worth over $200 billion annually in 15 years, including $96 billion in the United States. By comparison, Americans currently spend $77 billion, $65 billion, and $58 billion on cigarettes, wine, and spirits per year. About 80% of that market would consist of branded products, rather than dry marijuana flower.
Constellation Brands estimates that Canopy Growth will reach a $1 billion annual sales run rate in 2020 and that its investment in Canopy Growth could be accretive to its earnings as early as fiscal 2021.
The long-term tailwind could be much greater, though. In 15 years, Constellation Brands thinks Canopy Growth can capture 30% to 40% of Canada's $11 billion marijuana market, 5% to 15% of the marijuana market in the U.S., and 5% to 15% of sales everywhere else. Using the low end of those assumptions pegs Canopy Growth's annual revenue above $14 billion at that point.
Furthermore, Constellation Brands estimates that Canopy Growth's operating margin could be at least 30% in Canada and the U.S., and at least 20% everywhere else. If they're right, Canopy Growth would be generating roughly $3.7 billion annually in operating profit in 15 years. To put that figure in perspective, consider that Constellation Brands revenue was $7.6 billion and its operating income was $2.3 billion last fiscal year.
What to watch next
For the marijuana market to deliver these targets, a few things need to happen. First, efforts to legalize marijuana need to succeed. Second, legalization has to include products using marijuana as an ingredient, such as beverages. And third, Canopy Growth has to maintain its industry leadership. None of those things is a given.
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So far, Canada's the only big, developed market to OK recreational use, and it's yet to approve the sale of edibles or beverages. In addition, competition is stiff. Nipping at Canopy Growth's heels are a slate of well-financed players, including Aurora Cannabis (NYSE:ACB), Aphria (NASDAQ:APHA), Tilray (NASDAQ:TLRY), and Cronos Group (NASDAQ:CRON). Those are top-tier marijuana stocks, and none of them is going to willingly allow Canopy Growth free rein over this market. Therefore, investors will want to watch and see if other countries follow in Canada's footsteps, if Canada green-lights cannabis-derivative products such as beverages, and how competitors decide to battle Canopy Growth for market share.