Canopy Growth (CGC 2.41%) is one of the top cannabis companies in the Nasdaq Composite. Unfortunately, that's not enough to suggest that it's a safe investment -- or that it's profitable, or that its returns have even been good. Down a whopping 98% in five years, it has been an absolutely dreadful investment.
The company has been working on slashing costs as it looks to improve its financials, but it won't be an easy road ahead. One thing that might make it appealing to growth investors is if the U.S. marijuana market opens up.
Below, I'll look at the prospects for legalization along with where Canopy Growth may be three years from now, and whether it's worth taking a chance on this beaten-down pot stock.
Revenue could get even smaller
Canopy Growth has been scaling back its operations, particularly in Canada, where the market is incredibly competitive, making it difficult for cannabis producers to grow. It has divested its retail cannabis operations in Canada. And recently, it has announced plans to stop funding BioSteel, its sports nutrition business and one of its key revenue drivers in recent years, as that has proven to be a problematic, cash-burning operation.
The company is shifting to what it refers to as an "asset-light operating model," suggesting that it's trying to be as lean as possible in order to minimize costs and cash burn. But in the process, its revenue may get lighter as well. While Canopy Growth did generate sales growth during the early years following legalization in Canada (which took place in 2018), it has been on a significant decline of late.
CGC Revenue (TTM) data by YCharts
As Canopy Growth continues to focus on getting leaner, investors shouldn't expect the top line to show improvement over the next three years, and it's highly probable that its decline will continue.
The business is likely to remain unprofitable
Trimming its operations is a good move for Canopy Growth. Unfortunately, the Canadian pot market simply isn't a great one to focus on given all the taxes, the red tape relating to advertising and marketing, and the hundreds of cannabis producers it has to compete with there.
But the problem is that it might require too much work for the business to even have a chance of getting into the black. The one crucial number that needs to improve is the gross margin. If the company isn't generating enough in revenue to cover its cost of goods sold, there's little hope of it being able to cover its operating expenses.
In its most recent earnings results, for the period ended June 30, Canopy Growth reported a gross margin of just 5.9 million Canadian dollars. And that was an improvement from the negative CA$5.6 million gross margin it reported in the prior-year period. Canopy Growth's operating expenses totaled CA$97.3 million last quarter -- it is nowhere near close enough in gross margin to cover those expenses.
Without a drastic change in strategy, it just doesn't appear likely that, even over a three-year period, Canopy Growth will get anywhere near breakeven.
The U.S. pot market likely won't open up
The big carrot that Canopy Growth's management always likes to dangle in front of investors is the opportunity it will have once the U.S. marijuana market opens up. It has pending acquisitions involving multiple U.S.-based companies, including multi-state marijuana operator Acreage Holdings. That deal has been on hold since 2019, when it was first announced. The problem is that Canopy Growth can't close on those deals and incorporate the results from any U.S.-based pot business as long as marijuana remains federally illegal in the U.S. Otherwise, the Nasdaq may kick it off its exchange.
There would undoubtedly be new growth opportunities for the business to pursue in the U.S. if and when the market opens up, but I'm not optimistic that legalization will take place within the next three years. Republicans normally take a hard stance on drugs, and if Joe Biden wins a second term, that may also not lead to legalization -- the current president has not shown any interest in legalizing marijuana. While there are hopes that the Drug Enforcement Agency may reschedule cannabis from a Schedule I substance down to Schedule III, that doesn't mean legalization is inevitable.
Canopy Growth isn't a stock worth buying
While Canopy Growth may be a tempting option for contrarian investors, the risk involving the stock is incredibly high, and at this point, it isn't much more than a speculative buy. If you're interested in buying cannabis stocks, there are much better options to put in your portfolio than Canopy Growth.
