Amid the coronavirus disease 2019 (COVID-19) pandemic chaos, North American marijuana stocks have done surprisingly well. The cannabis-focused Horizons Marijuana Life Sciences ETF has jumped by a low double-digit percentage on a year-to-date basis through this past weekend.
But the largest marijuana stock in the world has delivered even more impressive returns. Canopy Growth (CGC 0.26%), the only large-cap pure-play pot stock, has gained 38% since the year began, and has more than doubled since the beginning of October.
Can this amazing run continue? Or would investors be wise to avoid the biggest marijuana stock? Let's take a closer look by analyzing the buy and avoid arguments.
Here's why Canopy Growth may offer additional upside
Being the biggest pot stock by market cap comes with its perks. One of Canopy's noteworthy advantages is its close-knit relationship with spirits giant Constellation Brands (STZ 1.22%). Constellation has made four direct and indirect investments into Canopy since October 2017 and currently holds a 38.6% stake in the company. With such a large take, Constellation has a vested interest in Canopy's success. This means collaborating on higher-margin cannabis derivatives and marketing or distribution assistance, when necessary.
In addition to having a high-profile equity stakeholder, Canopy Growth is also sporting an insane amount of cash, cash equivalents, and short-term investments, most of which is derived from Constellation's equity stakes. Canopy ended September with $1.72 billion Canadian ($1.32 billion U.S.), which is more capital than any other marijuana stock. This gives the company and its relatively new CEO David Klein, the former CFO of Constellation Brands, plenty of financial flexibility.
That brings me to my next bull thesis: Klein's no-nonsense business approach. Prior to Klein taking the helm in January 2020, Canopy Growth was hemorrhaging cash and losing a monstrous amount of money. Since taking over, Klein has shuttered over 3 million square feet of licensed indoor greenhouse space, reduced headcount, and dramatically cut share-based compensation. In the most recent fiscal quarter, share-based compensation declined to CA$22 million from CA$92.9 in year-ago quarter.
Lastly, there's optimism surrounding Joe Biden's victory last month. President-elect Biden has offered to reschedule cannabis and decriminalize the drug, raising hope that Canopy Growth might soon be able to enter the U.S. weed market. It's worth noting that Canopy already has a presence on U.S. soil via the hemp industry.
A laundry list of reasons for investors to avoid Canopy Growth
Now let's take a closer look at some of the reasons investors might be wise to avoid this stock.
The company's income statements are arguably alarming and good reason to keep your distance. Even though Klein has worked wonders in the cost department, Canopy Growth is still losing money hand over fist, and may continue to do so for years. In spite of record net sales of CA$135.3 million in the fiscal second quarter, the company's net loss totaled CA$96.6 million. Through the first half of fiscal 2021, it's lost CA$227.4 million. One-time losses aside, the company's expenses are still far too high relative to its gross profit margin.
Another concern for all major Canadian pot stocks is that they've been forced to compete with the black market on price. Canopy, like its peers, has been pushing value-branded cannabis. While it's been able to up its market share in the flower category, we've seen widespread declines in per-gram retail and wholesale pricing for dried flower. In other words, the company might be selling more weed, but it's not helping margins one bit.
To counteract one of the bull theses, investors would also be wise not to get too excited about the prospects of federal change in the United States. Biden has a long history of being anti-cannabis. A potentially Republican-controlled Senate will all but assure there's no chance of federal marijuana legalization. Rescheduling marijuana might also be terrible news for the U.S. pot industry. It's very possible Canopy Growth is still many years from entering the lucrative U.S. market.
Investors shouldn't overlook regulatory issues in Canada, either. Ontario, the largest province by population in Canada, is still playing catch-up on doling out dispensary licenses, while key provinces like Quebec aren't allowing high-margin cannabis vape products to be sold.
Now for the $64,000 question: Is Canopy Growth still a buy after galloping higher by 38% in 2020?
After weighing both sides of the argument, I'm still decisively in the avoid column. However, I am seeing tangible progress with David Klein's belt-tightening, which gives me hope that my view on the company won't always be negative.
Mike Lee, Canopy's CFO, recently announced initiatives that'll result in roughly CA$150 million to CA$200 million in annual cost savings, with cost of goods sold, general and administrative expenses, and inventory representing the core areas where future savings can be extracted. While I'm happy to see Canopy Growth aggressively addressing its huge net losses, it still worries me to see a company in what should be a high-growth industry trying to backpedal its way into recurring profits.
I'd also be remiss if I didn't mention Canopy's cash situation. Even though it's still lugging around a healthy CA$1.72 billion in cash, the company had closer to CA$5 billion two years ago. If not for a CA$245 million warrant exercise from Constellation a few months ago, Canopy's cash balance might have declined by almost 70% in less than two years.
Despite its nearly $11 billion market cap, Canopy Growth is still very much a work in progress.