Most cannabis investors know that Canopy Growth (CGC -6.78%) is one of the leading players in North America. Still, the company’s merit as an investment is a complicated topic, and that’s precisely where smart investors stand to teach most of the stock’s potential buyers a few important things.
In particular, there are three key facts about Canopy Growth that wise investors recognize, so let’s examine each.
1. It isn’t growing
As well-informed investors know, perhaps the most important issue facing Canopy Growth right now is that its revenue is shrinking rather than increasing. Compared to three years ago, its latest quarterly revenue of $81 million is down by 31%. But there isn’t a story of mismanagement or failed strategy to tell here. The factors driving the decline were largely beyond its control.
Its home market of Canada experienced a glut of cannabis because competitors in the recreational-use market overexpanded production capacity relative to demand. That prompted Canopy to divest its retail operations in an attempt to conserve its resources for wholesaling, among other purposes. Over the past 12 months, the market has started to show signs of revival, and Canopy’s fortunes may be turning, too. But smart investors likely also recognize that its trailing-12-month net loss of $917 million mean that it’s nowhere close to reaching profitability, which makes buying its shares a dicey proposition at best.
2. Its big play to enter the U.S. is closer to stalled than it is to blastoff
The U.S. market for marijuana is the world’s largest, and according to industry experts, it may be as large as $33.6 billion by the close of 2023. But Canopy can’t yet compete in the U.S. like a normal marijuana business. It has a somewhat convoluted plan to enter the U.S. market via a trio of acquisitions of local businesses, which are to be held by a parallel company, Canopy USA.
But Canopy does not hold a controlling interest in Canopy USA, which is something that smart investors understand; the shares it owns are not vested with voting power. Furthermore, it can’t report Canopy USA’s performance on its financial statements. And it can’t exercise its rights to convert its non-voting shares into a controlling stake until cannabis legalization occurs. Nor has Canopy USA actually acquired its targets yet.
Legalization might take longer than anticipated, and there does not appear to be any momentum for it in Congress at the moment. Therefore, the prospect of grabbing growth in the U.S. market will be a bit of a tortured subject for the company for the foreseeable future. Upon legalization, however, it should be off to the races.
3. It’s shuttering unprofitable segments and scaling down
Because Canopy is so unprofitable, it needs to trim some of its underperforming business units. The biggest segment on the chopping block is BioSteel, its sports drink subsidiary, which was driving top-line growth over the past year — and burning money every step of the way. Management has high hopes for the sale being a key factor in enabling the company to reach positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in the near term. It also just sold one of its cannabis facilities in Ontario on Oct. 2, capping off its divestiture of roughly $113 million worth of its properties since April.
Wise investors appreciate that it’s better for a business to scale down its unprofitable pieces than to run out of money and go bankrupt. At the same time, by definition, scaling down is the opposite of growth. That means the investing thesis for buying Canopy is, perhaps temporarily, shifting from a story of how it’ll grow and become profitable to a story about how its shares might have more value than the market is giving it credit for. And smart investors know that the value story is a far more palatable one, given the risks of growth stocks in general.
Alex Carchidi 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.
