2019 was a disappointing year for investors in marijuana stocks and particularly dreadful for shareholders of the largest one, Canopy Growth (CGC +2.00%). But the market always looks forward, and after plunging following a particularly horrible earnings report, the shares have rebounded 52% since mid-November. Is the market's optimism about the near-term future of the company justified? Let's look at what will change for Canopy Growth in 2020 and what will stay the same.
A new CEO will begin to leave his mark
Investors already knew that co-founder and CEO Mark Zekulin would be stepping down by the end of the year, but when the identity of Zekulin's replacement was announced in December, the market loved the pick and shares jumped 14% in a day. David Klein, chairman of Canopy's Board of Directors, will leave his position as Chief Financial Officer of Constellation Brands and take the reins on January 14.
The choice signals that Constellation Brands is strengthening its control of Canopy and intends to use its strong influence to see gains from its $4 billion investment sooner rather than later. The market clearly approves, and now Canopy's top two executives – CFO Mike Lee was previously CFO of Constellation's wine and spirits business – are veterans of the beverage giant with strong financial backgrounds and experience with consumer brands.
Image source: Getty Images.
Over the next year there's a possibility that Constellation Brands would acquire the remaining interest in Canopy Growth, but given the bigger company's high level of debt, it's more likely we'll see Canopy looking more like Constellation's subsidiary. By the end of 2020, expect more financial discipline at Canopy, with a clearer view of the path to profitability, something severely lacking now. The new team will also have more credibility with Wall Street analysts, who had been openly questioning some of Zekulin's optimistic assumptions about next year.
More pot stores will open in Ontario
A major reason for disappointment in results from Canadian cannabis producers in 2019 has stemmed from the slowness of the Ontario government to license new retail stores. Ontario is the largest potential market in Canada, but only has 24 stores for 14.5 million people. The provincial government announced in December that some of 42 proposed new stores will open this month and that about 20 new stores will open per month starting in April after a cap on the number of stores and a lottery system is abandoned.
That's only half the rate Canopy was hoping to see, but it's a big improvement. The government is making it a priority to move to an open market for retail cannabis stores, and a year from now, there will be much more clarity about the market and nice year-over-year sales comparisons, factors that will favor Canopy's share price.
"Cannabis 2.0" in Canada will ramp up
Canada opened its market to sales of edibles, vaporizers, and cannabis-infused beverages in December, and Canopy has been investing heavily in new production facilities and its sales organization to be ready to launch a variety of products this month.
It's fair to assume that there will be fits and starts to the roll-out, given the experience of the first year of adult-use marijuana in Canada. But clearly these products, especially beverages that are designed to compete with alcoholic alternatives, are a priority for Constellation and Canopy, and the companies will be working to establish the brands and get market share. A year from now, investors should have a view of the growth trajectory and the potential for the categories, and the stock could get a boost if the company's products have success early.
The vaping crisis may very well subside
Speaking of vaporizers, the tragic outbreak of lung injuries from vaping (EVALI) will delay the launch of those products in Canada and has contributed to the year's decline in marijuana stock prices. Even though Health Canada has legalized cannabis vaporizers, several provincial governments are holding off on granting permission of sales until more is known about the cause of the illnesses and deaths.
Although the crisis is not yet resolved, we may be at the peak of investor concern over the issue. The U.S. Center for Disease Control issued new findings in late December that strengthen the link between Vitamin E acetate and the illness. Experts from the CDC said that they believe the additive was the cause of EVALI in "the vast majority of patients." Emergency room visits for the illness have also declined since September.
Investors were initially worried that the outbreak could have a permanent effect on the sale of cannabis vaporizers, but if experts identify the cause or causes of the outbreak with certainty and companies can confirm the lack of those constituents in their products, the pressure on share prices could lift.
Canopy will be selling CBD products in the U.S.
Canopy recently launched First & Free, its line of hemp-derived CBD softgels, oils, and creams for the U.S. market. The company has been making investments in hemp cultivation and production facilities in order to capitalize on what could be a huge market for CBD products in the U.S.
The CBD products announced so far probably won't have much of an effect on the company's business in the near term, but the development in 2020 that could draw a lot more investor attention is Canopy's entry into CBD-based beverages in the coming months. The company acquired a majority interest in BioSteel Sports Nutrition in October, planning to use the brand as its platform to enter the sports nutrition and hydration market. A dozen new products based on CBD are set to be launched in the U.S. early in the year.
Some things won't change
Investors in Canopy Growth can expect that some things about the company's business, both bad and good, will be constants in the coming year. Its $300 million investment in Acreage Holdings is a call option on the federal legalization of marijuana in the U.S., a virtual impossibility in the politically charged environment of an election year. That complex deal won't bear fruit in 2020 but could throw off all sorts of non-cash accounting charges that could muddy the financial picture. And pricing fluctuations in the Canadian pot market could create more inventory adjustments and margin pressure for the company this year.
On the positive side, Canopy has a leading market share position in Canadian recreational pot, which should continue to boom. The company also has a net cash position over over $2 billion, which gives the new CEO plenty of options to invest in further growth.
On balance, less uncertainty a year from now
The net result of changes over the next twelve months should be a business with fewer question marks than investors have been seeing lately. The new CEO and the influence of Constellation Brands should add some stability, discipline, and predictability to Canopy's business, and that should benefit the share price. Moreover, the reasons for the huge investment that Constellation made in the company should start to come into clearer focus, and investors in early 2021 will be looking ahead to growth plans for consumer beverage brands in both the U.S. and Canada.
As with any company in a rapidly changing market, the biggest risk to Canopy Growth's stock in the year ahead is probably something we don't even know about right now, and investors should be prepared for ups and downs that are completely unpredictable. But the share price reflects concern over the known issues that will fade with time, and investors with patience and a long-term outlook will likely find today's price a reasonable entry point for the speculative growth stock.
