The stock market is currently in a state of turmoil, with investors spooked by the COVID-19 pandemic and its potential effects on the global economy. Year to date, the S&P 500 is down by 21% after climbing by about 29% last year.
However, this sell-off might have created opportunities to buy cannabis stocks at much more reasonable prices. For instance, Canopy Growth (CGC -2.08%), one of the largest pot companies by market cap, has seen its shares plunge by 34% since the beginning of the year. Canopy Growth's stock is now worth about $14 (at time of writing), but is now a good time to buy shares of the pot grower?
The buy thesis
In my view, the best reason to consider buying shares of Canopy Growth is the company's position in the Canadian recreational (adult-use) cannabis market. Canopy has a leading presence in many Canadian provinces. To quote the company's CEO, Mark Zekulin:
Canopy also continues to hold the strongest market share in the Canadian recreational market, with still over $1 in every $4 spent at the till being spent on a Canopy product in our estimation. Canopy is No. 1 still in Ontario, No. 1 in Nova Scotia, No. 1 in PEI and No. 1 in Alberta, the country's most developed market at over a 35% market share. In Québec, we are No. 2, only behind HEXO.
Canopy's leading share in the Canadian recreational pot market could become critical as the company looks to profit from potentially lucrative cannabis derivatives. Canada officially opened the market for derivative products -- such as vaping products, edibles, and cannabis-infused beverages -- on Oct. 17, 2019. Canopy unveiled its portfolio of derivative products in November. This portfolio included such products as Tweed RTD, a line of canned nonalcoholic beverages with several flavors, each containing 2 milligrams of tetrahydrocannabinol (THC). Canopy's portfolio of derivative products also includes a dark-chocolate product called Tokyo Smoke which contains 2 mg of THC and negligible traces of cannabidiol (CBD).
Canopy started launching its derivative products -- to be sold in legally licensed cannabis retail stores -- back in December 2019, and according to Zekulin, some of these products have been "selling out very quickly."
And the company could profit from the opening of more cannabis retail stores in Canada. Last year's slow rollout of retail cannabis stores hindered the sale of cannabis products, particularly in Ontario, the largest province by population. This problem arose in part because Health Canada was too slow to issue retail cannabis licenses. However, the government implemented some changes to the approval process for these licenses this year.
For instance, the government of Ontario previously had a cap on the number of retail cannabis stores allowed in the province; this cap has been removed. Also, cannabis companies were not previously allowed to open retail cannabis stores on their premises; that is no longer the case. Thanks to these changes, the number of retail cannabis stores will increase significantly in the coming months, which will benefit Canopy immensely.
The avoid thesis
There are several reasons to steer clear of Canopy. First, the ongoing COVID-19 outbreak could harm the company. Canopy recently decided to close its corporate-owned stores across Canada temporarily. And while Canopy set up e-commerce platforms to continue serving its customers during the outbreak, it isn't clear what effect the pandemic will have on the company's sales.
Second, Canopy's balance sheet isn't pretty. In particular, the company had a little more than 2 billion Canadian dollars in goodwill at the end of 2019. This much intangible value on the company's balance sheet could lead to significant writedowns in the future, which could hurt Canopy's bottom line.
Speaking of the bottom line, Canopy continues to post steep losses. During its latest reported quarter -- the third quarter of its fiscal 2020 -- Canopy recorded a net loss of CA$124.2 million. And although this was a significant improvement from its net loss of CA$374.6 million recorded during the second quarter, given the current market conditions, it might not be a great idea to invest in companies that haven't shown they can post consistent profits.
Finally, even after the recent market correction, Canopy is still an expensive stock. The company is currently trading at 13.95 times forward sales.
Canopy's stock is still far too expensive, and investors would be purchasing shares of a company that is not yet profitable amid a time of turmoil for financial markets and uncertainty for the global economy. In light of these factors, and although Canopy looks well positioned to profit from the Canadian pot market, investors would be better off staying away for now.