Anyone watching the cannabis industry knows that Canopy Growth (NYSE:CGC) is among the top companies in the space—along with Aurora Cannabis, Tilray, and a few others. Quite possibly, it is the top one itself.
The Smith Falls, Ontario-based company has a market cap over $14 billion with 230 million shares out, and US$17 million in revenue in the last quarter— a pace of $70 million per year. Its revenue per share is $0.35—better than most competitors. On the bottom line, it is still losing money, as virtually all fast-growing cannabis businesses are, because it is re-investing more than its revenue in new facilities, to stay ahead of competition. That’s good in my book.
Canopy is leading the pack in global expansion. While some companies are still building their first grow facilities, Canopy is already developing businesses or partnerships in 11 countries on 5 continents. Most recently, it jumped into the USA for the first time, buying a hemp farm in New York state. This came just one month after the US passed the its Farm Bill 2018 making hemp totally legal in the US. I love the speed of that move.
Hemp is cannabis with virtually none of the THC that makes people high. Some people think recreational use is where all the money is, but hemp has many profitable uses. Among the most promising is the CBD market. Hemp contains CBD and other cannabinoids that have health benefits and are driving a fast-growing market in health supplements and new treatments for pain, epilepsy seizures, chemo-induced nausea, and other uses worldwide.
Canopy doesn’t enter countries where the federal law prohibits its product. But once hemp was legalized in the US, Canopy jumped. And the long-term prospects for hemp are excellent. The global market for CBD is close to $4 billion now, with about $900 million coming from the US. The market could grow by double digits annually for the coming 5 years or so.
Canopy is impressive on many fronts—I have barely scratched the surface. But despite it being one of my favorite companies, I have for some time felt that the company was not a good investment. Why?
Price, price, price. I tend to be a long-term investor, so I need the price to be reasonable. Many of you like to play a short game, buying this month, selling next month before it drops. That is admirable, but it requires daily attention, staying up on every piece of news. I prefer to play it safer, and buy stocks I think are solid for the long term, so I don’t have to watch all the details every day. While I miss some short-term gains, I also miss a lot of losses.
Another reason I prefer the long-term game is that I am better at knowing when to buy, than knowing when to sell. And I don’t have to watch the stock every day and worry if it’s time to sell.
I look for stocks I feel are priced well for the long term, according to their revenue or profit. This means, I look for good value. And I feel Canopy is overbought.
Because so many investors like Canopy, and believe it will be the king of cannabis, they have bid the price of the stock to astronomical levels relative to its revenue. From August through October last year, the stock was over $40 a share, when the company was bringing in only CAD$20 million per quarter, and losing money on the bottom line. This put their price to sales ratio at an astronomical level, well over 100. Most companies’ price to sales ratio is well below 10, often close to 1. With price so high relative to sales, it looked like the stock was priced for revenue close to $2 billion, when it was still only bringing in $80 million a year.
Despite my confidence in Canopy’s future success, I am not sure it will get from CAD$70 million to $2 billion anytime soon, with all the competition in the market. Their revenue has been flat for a year. And I feel the stock price will never be stable at a $40 price until it gets to $2 billion.
You can bet I took notice in December when the stock fell, along with much of the industry, down to $26/share. Was that a buying opportunity?
In hindsight, it was. This month it has shot up again, up 50%, after Canopy’s US hemp investment, and sits at about $50 per share now. So we can say, due to extreme investor confidence, Canopy was a definitely a buy opportunity at $26.
I didn’t buy at $26. I was tempted, but the price to sales ratio was still high, and I was cautious. I had bought early last year at $17 and rode it up to the high 30’s, and made a nice profit when I sold. I was not in a rush to jump back in at $26. I was playing the long game and felt it was still priced for revenue close to $1.5 billion, so I decided to watch instead.
Then it rose 50% with the good hemp news, this time to $50. It seems excited investors like it above $40, priced for $2-3 billion of revenue. I can see now that the next time it drops to the mid 20’s—if it does—many investors will be waiting for news to pile back in. So if it drops again, I’ll get back in. Or if its revenue skyrockets this year, as it should, without the share price rising too far, I may buy. I love the company. I just want to buy when I feel confident it can make the revenue implied in the price—so the stock is likely to rise.
I won’t buy the stock now. Above $40, it’s just too high relative to current revenue. But I’ll be watching closely the next time it falls.
John Farmer watches the cannabis industry for Cannin.com