Houston, marijuana stocks have a problem.
Despite the industry being forecast to grow by a strong double-digit percentage over the next decade, and perhaps even generating $200 billion in worldwide annual sales by 2030, pot stocks simply can't catch a break as of late. Through this past weekend, the Horizons Marijuana Life Sciences ETF, a cannabis exchange-traded fund with roughly five dozen holdings of various weightings, had declined by close to 60% since peaking on Oct. 15 of last year. Arguably leading the charge lower is Canopy Growth (CGC +0.46%), the largest marijuana stock in the world by market cap.
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Canopy Growth may have downside of 28% still to come
In just one year, Canopy Growth has shed two-thirds of its value, working out to more than $10 billion in market cap. As recently as last month, Yours Truly offered a list of 10 reasons why I felt Canopy Growth could fall more than 20% from where it had been trading to less than $20 per share. On Friday, Oct. 11, this prognostication proved accurate, with Canopy Growth closing at $19.43.
However, a sub-$20 share price doesn't mean Canopy Growth is now a value stock. On the contrary, with a number of negatives building, I'd opine that this stock might only be worth $14 a share, and therefore have another 28% downside to come.
First, I'll go over some of the broader issues impacting Canopy and the entire cannabis industry, then I'll offer the specific data that has me believing $14 is where this company is headed next.
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These broad-based issues are bad news for the entire industry
Since the first day of recreational legalization one year ago (as of tomorrow), Canada has been contending with supply issues. These issues can be traced back to three sources.
For one, we've seen regulatory agency Health Canada unable to keep pace with its enormous backlog of cultivation, processing, and sales license applications. Even with the agency implementing changes to the cultivation license application process, it's going to take numerous quarters before this backlog has been dealt with.
Second, we've also witnessed delays in the rollout of physical dispensary stores in certain provinces. With far too few open retail locations, consumers have had to either buy online and wait for their product to arrive, or turn to the illicit market.
Third, the growers also deserve some semblance of blame for tackling capacity expansion projects far too late.
What's more, tomorrow's legalization of derivative pot products – e.g., edibles, vapes, infused beverages, topicals, and concentrates – won't see these products hit dispensary shelves until mid-December. And even when these high-margin derivatives do work their way onto dispensary shelves, they're liable to face the same supply issues that've been wreaking havoc on the industry for a year.
All of these issues sums up why Canopy Growth's sales projections (and the entire Canadian industry, for that matter) have been tumbling in recent quarters.
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A mountain of problems for Canopy Growth
But there are no shortage of company-specific problems, either.
For example, the company still has no permanent solution at CEO after the firing of co-CEO Bruce Linton in early July. Linton was the company's visionary since its founding, and was the architect behind every major acquisition, as well as Constellation Brands' game-changing $4 billion equity investment into the company. When a new CEO is found, now-current CEO Mark Zekulin, who served as co-CEO with Linton, will also be stepping down. In effect, there's no clearly defined game plan for the company moving forward.
Another issue is that Canopy Growth has bet big on international markets, and these overseas sales channels are nowhere near paying off. Canopy currently has a presence in 17 markets, including Canada, with a core focus on the U.S. market. Unfortunately, the U.S. federal government is nowhere near giving a green light to marijuana, meaning Canopy's contingent-rights buyout of Acreage Holdings is on hold for who knows how long.
This is also a company that's been crushed by skyrocketing expenses. More specifically, Canopy has seen its share-based compensation shoot through the roof. Prior to his departure, Linton's philosophy had been to give the company's growing employee base long-term-vesting stock to keep them loyal. But this has led to huge costs on the company's end, which is a big reason why operating expenses totaled 229.2 million Canadian dollars in the fiscal first quarter. Share-based compensation is, by far, the company's largest single quarterly expense.
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Here's how $14 comes into the picture
The company is clearly contending with industrywide problems, as well as a host of company-specific issues. But I've failed to mention perhaps the biggest issue of all: Canopy's CA$1.93 billion in goodwill.
Canopy Growth has been an aggressive acquirer in recent years. With pretty much all of these acquisitions has come a premium the company has paid above and beyond tangible assets. Ideally, Canopy is going to recoup the full value of its goodwill by developing the assets and monetizing the patents of the businesses it's acquired. However, things rarely go ideally in a nascent industry. I find it much more likely that Canopy Growth will see at least half of its goodwill, if not more, written down.
Further, this is a company that could be among the last to generate a recurring profit. Even presuming that the new CEO focuses on tightening the belt, I don't see how Canopy's operating expenses come in lower than CA$800 million in 2020. And I believe this to be a conservative estimate on my part. While the company does have more than CA$3.1 billion in cash and cash equivalents, I'd be shocked if, between minor acquisitions and operating losses, we didn't see CA$500 million to CA$700 million, at minimum, in cash outflow over the next year.
So, to sum things up, I believe Canopy Growth's total assets could decline by at least CA$1.5 billion, with the potential for up to CA$3 billion, if the entirety of its goodwill is written down, and the company loses money for another two years. When combined with no near-term chance of profitability, I suspect that could reasonably knock $5 (about $1.5 billion in market cap) off of Canopy's existing valuation, placing it at $14.
Will this prognostication prove accurate? Only time will tell.
