With the citizens of Ohio voting by ballot initiative on Nov. 7 to legalize recreational marijuana use for adults, there will soon be yet another state cannabis market opening in the U.S. Marijuana stocks, including Canopy Growth, (CGC 2.41%) rose on this encouraging news. Industry experts see the Ohio market being worth as much as $4 billion within the next few years.
But how does that contribute to or change the investing thesis for Canopy Growth? Does it make this stock worth considering more closely now?
Canopy still faces a lot of barriers
As you may know, Canopy is a Canadian marijuana cultivator with big (and somewhat confusing) plans for the U.S. market. Long story short, its management didn't want to wait any longer for the country to legalize cannabis at the federal level before starting to compete. So last October it adapted its existing plans to acquire a trio of cannabis companies upon federal legalization using a workaround.
It created an American parallel organization, Canopy USA, which would be responsible for its operations in the U.S. Canopy USA could thus move forward with the acquisitions before federal legalization, at least in theory. Then, down the line, the Canadian business could convert its initial stake, comprised of non-voting shares, into common shares of Canopy USA, thereby enabling it to report that business' results as its own as far as shareholders and regulators are concerned. Successfully completing this governance workaround would mean that it would be a significant driver of new revenue when additional states legalized recreational marijuana use.
But this convoluted process has gone badly awry. While its ambition originally called for Canopy USA to close two of its three planned acquisitions before the end of the first half of its fiscal 2024, that deadline has passed without any tangible progress being made. Both the Nasdaq stock exchange and regulators at the Securities and Exchange Commission (SEC) have voiced objections to the plans to consolidate the two entities. Therefore, the company still cannot legally report a single dollar made by Canopy USA as its own, as the businesses are in fact wholly independent from each other in the eyes of the law.
Federal legalization would help the business to escape the pickle it's in. The Drug Enforcement Agency (DEA) is currently evaluating whether to reschedule cannabis. It could propose a change to federal law as soon as early 2024, but even that would not result in cannabis legalization nationwide on its own. Further state-level legalization could still occur in the coming election cycle. Each new state market represents additional growth opportunities for Canopy USA, but because it can't yet realize its planned acquisitions, it doesn't even matter (at least not yet).
Look for better options
Aside from the ongoing challenges with its plans to expand into the U.S., Canopy is burning cash, and it is not making substantial progress toward becoming profitable. Its revenue is also shrinking year-over-year due to the saturation of the Canadian market; its quarterly sales are down by 56% compared to three years ago, reaching CAD$70 million in its fiscal second quarter.
It's also heavily indebted and liquidating its assets to cover its operating expenses. Its CAD$446 million in trailing 12-month cash flow from continuing operations was made possible by sales of property, plants, and equipment, as well as its sales of entire businesses.
Even if it finds a way to consolidate its U.S. and Canadian organizations, penetrating the U.S. markets will be expensive, and will likely involve a longer period of unprofitability. It may need to issue new stock, diluting the current set of shareholders, to raise capital. After all of that, it will need to fight other companies to retain customers, and it has no demonstrable competitive advantage with which to make that battle easier.
You probably shouldn't buy Canopy Growth stock. The risks far outweigh the potential benefits over at least the next year or so. Either go for a domestic multi-state operator (MSO), or a multinational company that isn't encumbered by governance issues.
