The past few months have been tough for large-cap pot stocks. Some companies, such as Aurora Cannabis, have had significant layoffs in an attempt to get their losses under control.

Canopy Growth (CGC -0.28%) has also had its fair share of difficulties. Between the departure of its longtime, iconic co-CEO, Bruce Linton, significant management team changes, and some startlingly high quarterly losses, Canopy Growth has lost much of its appeal over the past year.

However, things might be turning around for Canopy. With the company reporting a better-than-expected third quarter, the worst may be finally over for this battered cannabis giant. Let's find out whether now's the right time to buy Canopy or whether the stock could still fall even further.

A person holding a paper cutout of a marijuana plant as people walk down a street in the background.

Image source: Getty Images.

A decent third quarter

Canopy reported net revenue of CA$123.8 million in fiscal Q3 2019, an almost 50% increase from the CA$83.0 million reported last year. What's more impressive is that Canopy's gross margin (before fair value changes and other accounting measures) has improved as well, growing from Q3 2018's 26.1% of net revenue to Q3 2019's 33.8%.

While the company is still reporting a net loss -- something that's unlikely to change for a while -- it is an improvement from a terrible previous quarter. Net losses came in at CA$124.2 million, a significant improvement from the CA$374.1 million loss seen just three months ago.

Why Canopy's cash pile might not be enough

Canopy is perhaps the best-funded cannabis stock on the market right now, with $2.3 billion in cash, cash equivalents, and marketable securities on its balance sheet. While this might seem pretty good on paper, Canopy's cash pile may not last as long as one might expect. For one, Canopy has seen its total cash position decline by $430 million in just three months, a significant decline in such a short time.

If these losses don't drastically slow down, Canopy's enviable cash position could quickly dissipate within a few quarters. Operating expenses remain staggeringly high at about $231 million, and Canopy's new CEO, David Klein (the former CFO of Constellation Brands), will need to find a way to rein in this figure. Canopy Growth also forked out $56.7 million in share-based compensation expenses. While former co-CEO Linton figured that providing stock to employees would help motivate them, now it seems this decision has become a major liability for the company's finances.

Perhaps the biggest financial worry for Canopy is the possibility of a goodwill adjustment. Aurora Cannabis, which had over CA$3 billion in goodwill on its balance sheet, ended up having to announce a CA$775 million write-down recently. In short, goodwill is the premium a company is willing to spend on an acquisition target beyond its total assets. A bit of goodwill can be a good way to sweeten a proposed buyout deal. However, when companies are paying exorbitantly high premiums to buy out other firms, accumulated goodwill can become a serious liability to a company's balance sheet.

That's more or less what major cannabis companies have been doing in 2018 and the first quarter of 2019, gobbling up smaller competitors and letting their goodwill figures skyrocket. Now we're seeing these same companies pay for this, with Aurora being just the first example. While Canopy's intangible assets aren't as bad as Aurora's, coming in at $2.1 billion, that's still 31.6% of the company's overall $6.64 billion market cap.

 Company  Market Cap Quarterly Net Revenue Net Income (loss) Cash and Equivalents Goodwill and Intangibles Price-to-Sales Ratio
Canopy Growth $6.64 billion $123.8 million $124.2 million $2.3 billion $2.1 billion 23.8

Data source: Canopy Growth, YCharts. All figures in CA$0.

Should Canopy end up having to face goodwill adjustments of its own soon, it wouldn't be surprising for shares to fall significantly as hundreds of millions if not billions of dollars are erased from its balance sheet.

The state of the Canadian pot market

Although Canopy does have some hemp processing facilities in New York, the company primarily operates in the Canadian market. That country has had a disappointingly slow rollout of dispensaries, with certain provinces like Ontario having experienced supply issues for most of 2019. Because of this, the black market in Canada remains quite prevalent, further hurting the sales of legitimate producers since black market dealers can offer cheaper prices.

While pot sales in Canada were up 8.1% in December, bringing the nation's total non-medical cannabis expenditures to about $1.2 billion, that's not all that impressive when you consider that Colorado alone -- a state with a population of 5.7 million -- saw marijuana sales reach $1.8 billion. In comparison, Canada's entire population is about 37.6 million.

Inventories are rising for pot producers across the market, leading to an overabundance of cannabis that has further pushed down selling prices. Canopy hasn't been immune to this problem, reporting more than a year's worth of inventory stockpiled by the end of December (about CA$622 million worth). To put that in perspective, three months ago Canopy reported inventory of CA$461.8 million, meaning that figure has gone up by CA$161 million in just a single quarter. While Canadian cannabis sales are growing, it's worrying to see Canopy's inventory levels expand at such a fast rate.

A person holding a marijuana plant up to the sun in an open field.

Image source: Getty Images.

Regarding international markets, Canopy has been doing pretty well. Its medical marijuana business has seen Canadian revenue fall by a few percentage points, whereas revenue from international markets has gone up by almost 700%. As other EU countries open up to medical marijuana imports from other markets, Canopy could see revenue in this area improve.

Canopy remains fairly expensive

While Canopy Growth is still considered the leader of the cannabis industry, whatever prestige the company receives from this fact isn't enough to justify a pricey valuation. Fellow cannabis leaders Aurora, Tilray, and Aphria are trading at price-to-sales (P/S) ratios of 7.2, 10.5, and 2.7 respectively, while Canopy trades at a pretty hefty 22.9. While that's not as bad as some others (like Cronos Group, which is still trading at a whopping 67.1 P/S), Canopy is still pricier than most other pot stocks on the market. 

Given everything, it's hard to justify Canopy's valuation, especially when companies like Aphria are trading at cheaper premiums and offer much more bang for their buck in terms of profitability. Maybe if the Canadian market were doing better, Canopy's premium would be justified, but currently, that's not the case.

What should you do?

Investors shouldn't get their hopes up too much over a potential turnaround. Whether because of Canopy's significant quarterly losses or the possibility of a major goodwill adjustment in the near future, there's a good chance that shares will continue to fall. Considering that Aurora and Tilray have both announced major layoffs, it wouldn't be surprising if Canopy follows suit as well in a similar move to cut costs.

If you want to play the long game with Canopy and have already bought shares, then I'm not going to try to convince you to sell your stake. However, if you're on the fence, I don't think now's the time to buy. Canopy isn't the worst pot stock on the market, but I don't think it's anywhere near the top, either. Wait for another quarter or two and see how Canopy's results turn out before revisiting this stock.