On Oct. 25, the Canadian cannabis company Canopy Growth (CGC -0.30%) announced that it wasn't going to wait for marijuana legalization to occur in the U.S. before proceeding to enter the country's market. With the implications of that major announcement upending investors' prior assumptions, it's no surprise that its shares have risen by more than 70% in the last month.
But there could be even more growth on the way. For investors looking for an entry into cannabis stocks, Canopy's decision might be an attractive place to start. Here's why.
These strategic plays could be a setup for future success
Canopy's attempt at a foray into the U.S. market comes hot on the tail of its late September decision to divest its retail cannabis business in Canada. Selling off its retail outlets is expected to result in annual cost savings between CAD$70 million and CAD$100 million -- a significant sum when considering its fiscal year 2022 total operating expenses were near CAD$509.2 million.
Management's motivations are quite clear: Reduce the company's footprint in the over-saturated Canadian market to save on overhead costs, and increase its ability to cash in on the growing American market as it opens via state-level or federal marijuana initiatives.
The shift needs to happen for a couple of reasons. First, Canopy's net revenue shrank by 10% year over year as of its latest earnings report, from the second quarter of its fiscal 2023. Its Canadian cannabis sales plummeted by 27% compared to a year prior, indicating a severe mismatch between its products and the level of demand in the market. And while its gross margin is improving relative to its mid-year lows, it still isn't profitable, and there's no clear trend toward profitability either. So there's little incentive to keep funneling more resources into competing in Canada when the U.S. market is beckoning.
Regarding the details of its entry into the U.S., Canopy's newly formed entity, Canopy USA, will gain the option to purchase up to 100% ownership of a trio of U.S.-based marijuana companies. There's Acreage, which has locations in New Jersey and New York, another business called Wana that's based out of Colorado, and a third called Jetty, based in California.
While it's doubtful that any of the three would immediately contribute to the bottom line, they do bring several new brands into Canopy's portfolio, not to mention regional distribution networks that may come in handy.
But shareholders need to assent to the deals during a special meeting in January in order for the actual acquisitions, which are likely to be made using shares of Canopy stock, to move forward. Critically, per the terms of the transaction, Canopy's shares won't have voting rights or direct control of Canopy USA, nor will they have any economic interest whatsoever, though the shares of the U.S. entity will ultimately be convertible into Canopy shares. That'll come in handy in the event of a catalyst like marijuana legalization.
What you should do
Canopy's plan to compete in the U.S. makes it a more attractive prospect than Canada-focused companies like Aurora Cannabis. At the same time, its success in the U.S. market is not guaranteed. Therefore, investors should approach the stock with the understanding that it's essentially a turnaround play. That means it's quite risky, and it probably isn't the right opportunity for most investors.
If the prospect of getting a (large) haircut on your investment isn't too scary, starting a small position in Canopy stock in the next few months could be a smart move. Assuming the company ends up exercising its options to enter the U.S. market -- and it probably will over the next few years -- it'll likely be returning to revenue growth.
While reaching profitability will remain a distant goal, two of the businesses Canopy has the option of buying, Jetty and Wana, are focused on selling high-value-added products like vapes and edibles, which could help to shore up margins somewhat. And if more states legalize marijuana, its acquisition targets will give it decent geographical coverage throughout the country, so it should be positioned to benefit.
The linchpin of this strategy depends on the persistence of robust demand for cannabis in the U.S. If the market starts to get saturated, much like it did in Canada, it'll make top-line growth much harder to come by, and the market won't like it. So be on the lookout for burgeoning inventories, falling average selling prices, and delays with legalization in states where it was expected to pass, as each of those developments will point to hard times ahead for Canopy and its competitors.