Please ensure Javascript is enabled for purposes of website accessibility

3 Reasons I'm Cautious About Canopy Growth Stock

By Mark Prvulovic – Aug 7, 2020 at 11:02AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Not all is rosy for this cannabis giant. Here are a few things you should keep in mind about Canopy.

Canopy Growth (CGC -2.84%) is one of the best-known names in the cannabis industry. However, like many large-cap Canadian cannabis companies, Canopy has fallen on tough times over the past year and a half. Its ongoing financial woes, the departure of its iconic former CEO (Bruce Linton), and the COVID-19 pandemic have all contributed to its troubles.

However, Canopy Growth still remains one of the largest companies in the industry with a market cap of CA$8.7 billion. The stock is trading at a discount to its year-ago price, meaning some investors might think now is a good time to add it to their portfolio.

I'd caution investors against getting too optimistic with Canopy Growth, even if it does look cheap. Here are three reasons why you might want to be cautious when it comes to this company.

Marijuana plant leaf on an American dollar bill.

Image source: Getty Images.

1. A chronic lack of profitability

Canopy has always struggled to make a profit from its operations. To be fair, that's fairly common among cannabis companies, only a handful of which have managed to report profits over the past year or so. However, the sheer size of some of Canopy's past quarterly losses should make investors worried.

In its recent fiscal Q4 financial results, Canopy reported a CA$1.3 billion net loss for the quarter. That's a staggering amount for a company whose market cap is about CA$8.7 billion. Nor is this the first time that Canopy has reported a billion-dollar-plus loss. Back in August 2019, the company shed CA$1.2 billion during its fiscal first quarter.

Of course, Canopy doesn't lose a cool billion every quarter. But losses of this size are frequent enough that investors should be getting a little worried. The reason Canopy hasn't collapsed under the weight of these losses is its enviable cash position. As one of the best-financed cannabis companies in the industry, Canopy has been supported extensively by Constellation Brands (STZ -0.07%), which invested CA$5 billion into the cannabis company back in 2018.

The problem, however, is that this cash reserve is evaporating quite quickly. About a year ago, Canopy had CA$2.5 billion in cash and cash equivalents alongside an extra CA$2 billion in short-term investments. Now the company has only CA$1.3 billion in cash and cash equivalents, with just CA$673.3 million in short-term investments.

That's still quite a bit of cash, but it's a far cry from last year's totals. Burning through billions of dollars in such a short time is certainly a little bit worrying. The company's new CEO, David Klein, previously worked as Constellation Brands' CFO and has emphasized the importance of reigning in Canopy's runaway finances. Considering his background, Klein certainly has the financial acumen to pull this off, but it's not going to be easy.

Financial figures besides a stock chart and a pen.

Image source: Getty Images.

2. An overabundance of goodwill

Goodwill is a type of intangible asset that represents the premium a company pays to buy out another business. These premiums are a normal part of the acquisition process, so a lot of acquisitions mean a substantial increase in a company's goodwill.

When times are rosy, large goodwill figures aren't an immediate issue. However, when the market turns sour, all that goodwill becomes a potential liability. The figures often end up being revised or adjusted -- lower -- to better represent the current market climate. This can result in some major losses for the company in question.

That's exactly what has happened with many of the top Canadian cannabis companies already. Aurora Cannabis (ACB -1.94%) is one of the biggest examples, having reported a CA$1 billion goodwill adjustment back in February. In response, shares of Aurora plummeted. Something similar could easily happen to Canopy Growth as well.

During its recent fiscal fourth quarter, Canopy reported a massive CA$2 billion in goodwill on its balance sheet. That's more than Canopy has in total cash reserves at the moment. While it's uncertain exactly when (or even if) the company will end up having to make a goodwill adjustment in the future, that CA$2 billion is a potential ticking time bomb that could result in further losses down the road.

3. The stock isn't really that cheap

While it's definitely priced lower than it was a year ago, Canopy is still quite expensive compared with its competitors. The company's price-to-sales (P/S) ratio comes in at 20.5. Aphria, another Canadian cannabis company -- and one that's managed to be profitable for quite a few quarters this past year -- trades at a P/E of just 3. Aurora Cannabis has a P/E ratio of 4.3, while one of the most profitable small-cap pot stocks, Village Farms International, trades at a P/E of just 2.2.

Q4 Results Net Revenue Net Income (Loss) Cash and Cash Equivalents Short-Term Investments Goodwill P/E Ratio
Canopy Growth $398.8 million ($1.3 billion) $1.3 billion $673.3 million $2 billion 22.3

Data source: Canopy Growth, YCharts. All figures are in Canadian dollars.

While Canopy is much larger than the other businesses mentioned above, it's questionable whether investors would get a better bang for their buck investing in another, cheaper cannabis company. That's especially true given that some of these -- such as Aphria and Village Farms -- have proven to be profitable in the past. Although Canopy's partnership with Constellation Brands is a big reason why the cannabis company is valued so highly, it's hard to justify the stock just on this basis.

Canopy isn't necessarily a bad company by any means. There's still plenty of growth potential for the company over the coming years. It's just that investors need to be mindful of some of Canopy's glaring weaknesses in comparison to its competitors.

Mark Prvulovic has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.