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Is Constellation Brands Making a Big Mistake?

By David Jagielski - Jan 22, 2020 at 3:37PM

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Its marijuana investment may be more trouble than it's worth.

Things weren't supposed to turn out this way for Constellation Brands (STZ 0.55%). The company's investment in Canopy Growth (CGC 10.34%) was intended to generate strong growth while diversifying the company's business.

Unfortunately, Constellation Brands has seen loss after loss from the cannabis producer pull down its results. While some growing pains were inevitable, there's not much light at the end of the tunnel. Investing in the cannabis industry has been an expensive $4 billion bet for Constellation Brands, one that the company may want to consider walking away from sooner rather than later.

Another quarter weighed down by cannabis losses

Constellation Brands reported its third-quarter earnings earlier this month, which offered no surprises for investors: Canopy Growth dragged down the company's results, yet again. Although Constellation reported a profit of $366.5 million in Q3, the beer maker still incurred a loss of $71.1 million relating to its investment in the Canadian cannabis company.

Unfortunately, this is not a new problem, as a lack of profitability has been a recurring issue for Canopy Growth. In July 2019, Canopy Growth fired co-CEO Bruce Linton after another disappointing quarter dampened Constellation's numbers. The move rocked the industry and, even though Linton has since moved on, Canopy Growth continues to incur losses.

Map of Canada with cannabis leaf logo on top

Image source: Getty Images.

Over the past four quarters, the cannabis operator has accumulated net losses totaling 1.9 billion Canadian dollars on revenue of just CA$344 million. There's little hope of improvement around the corner as the company is bogged down in overhead and administrative costs. Selling, general and administrative costs totaled CA$241 million last quarter, which was more than triple the company's top line of CA$77 million.

There's a lot to fix at Canopy Growth, and what was initially an exciting investment in a new industry is looking like more and more like a burden on Constellation Brands.

Constellation is bullish on the Canadian marijuana market, but it shouldn't be

Despite the painful results, Constellation Brands isn't showing any signs that it's throwing in the towel on Canopy Growth anytime soon. The company's CEO Bill Newlands said, "We remain bullish on the Canadian cannabis market as the conversion of the illicit market to the legal market continues to strengthen."

It's been more than a year since recreational pot use became legal in Canada on Oct. 17, 2018, but there's not a whole lot to be bullish about today. Data from Stats Canada suggests that less than one-third of cannabis users buy pot from legal sources. Although that figure will likely rise as more cannabis stores pop up, legal pot prices are still far more expensive than what users can buy from the black market. Numbers from October indicate that illegal pot was nearly half the price of what consumers would pay from a licensed cannabis retailer. 

The reality is that while there may be some improvements in the Canadian cannabis market with edibles and ingestibles now becoming available, that's not enough to make it an appealing market in which to invest. Cannabis research company BDS Analytics adjusted down its forecast for the cannabis industry in Canada last year from a projected market size of $5.9 billion by 2022 to only $5.2 billion by 2024.

That's not a terribly high number when you consider that Green Thumb Industries CEO Ben Kovler expects that the recently legalized Illinois market alone can be worth as much as $3 billion. The California market is already worth more than $3 billion, and that's with a very strong black market still jockeying for position there. 

What does this mean for investors?

Constellation Brands isn't going to say it's dumping Canopy Growth because it's been a horrible investment, even if it really believes that. Doing so would only send the marijuana stock down even further in price. 

Instead, the takeaway for investors is that Constellation Brands will keep seeing its numbers weighed down by Canopy Growth for the foreseeable future, as there's little hope of a drastic improvement happening anytime soon.

Another takeaway is for the broader cannabis industry: Companies from other industries may be more hesitant to get involved in the cannabis industry in Canada in light of the challenges that have plagued Constellation Brands since its big pot investment. That means investors shouldn't expect any big deals to happen anytime soon involving beverages or any other industries.

Canopy Growth may well turn things around, but it could take a very long time for that to happen. In the meantime, Constellation Brands' stock is likely to remain on a very turbulent path, and investors ought to steer clear of it for now.

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Stocks Mentioned

Constellation Brands, Inc. Stock Quote
Constellation Brands, Inc.
STZ
$244.37 (0.55%) $1.34
Canopy Growth Stock Quote
Canopy Growth
CGC
$5.55 (10.34%) $0.52

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