Canopy Growth Corp. (TSXV:CGC): Can This Stock Sustain Its High?

Ever since the Liberal Party of Canada’s majority win on October 19, 2015, medical marijuana stocks have been all the buzz. Canopy Growth Corp. (TSXV: CGC), being one of the most well know, has been hitting multiple 52-week highs, and has now gained 66% YTD at $3.42/share. But is this stock’s surge warranted, or will investors quickly see their profits go up in smoke?

Alex Cutulenco | November 6, 2015: Justin Trudeau was recently sworn in as Canada’s 23rd Prime Minister. With it, comes great responsibility, and a heavy load of promises to act upon, one of which being legalization of marijuana across the country in an attempt to boost the Canadian economy and drive incremental tax revenue to the Canadian government. Ever since the Liberal Party’s majority win on October 19, 2015, medical marijuana stocks have been all the buzz. Canopy Growth Corp. (TSXV: CGC), being one of the most well know, has been hitting multiple 52-week highs, and has now gained 66% YTD at $3.42/share. But is this stock’s surge warranted, or will investors quickly see their profits go up in smoke?

Market Potential

In an effort to figure out the true potential of such companies, we first need to understand the market potential. According to M Partners (Figure 1), the Canadian cannabis industry is expected to rake in $6.5 billion in 2024. The research firm provides such a long-term projection for two reasons: a) regulation and market acceptance will take time to develop, and b) it will take time for cannabis to penetrate the Canadian market. In effect, this projected market will impact Canada in due time, and will only increase its GDP by a mere 0.36%.

During Justin’s campaign, he indicated that the Liberal party would start working on the project

“right away,” suggesting that changes in legislation would occur in the first half of his term. However, the Liberals have conceded that it will take time to form a framework on taxes, access and control.

For further reference, an analyst at GMP Securities estimated that “the Canadian recreational marijuana market could reach up to $4-5b annually at maturity.” As a reference, Health Canada estimated that by 2024 the market for medical marijuana could reach $1.3-1.4b annually.

Canopy Growth Corp.

Canopy is the parent company of Tweed Inc. and Tweed Farms Inc., both licensed producers of medical marijuana in Canada. The principal activities of Tweed are the production and sale of medical marijuana and the principal activity of Tweed Farms is the growing of medical marijuana as regulated by the Marihuana for Medical Purposes Regulations.

      Company reported $1.7million in revenue for the three months ended June 30, 2015

      Company is trading at 40.5x Revenues (last quarter annualized)

      Company’s cost of sales is higher than revenues, implying a negative gross margin of roughly -39.4%

      Company has negative operating cash flows at -$3.3 million for the last reported quarter

It is also important to note that Tweed’s Commercial License has a current term of renewal on November 18, 2015. Tweed’s Commercial License currently allows Tweed to produce up to 3,500kg of medical marijuana per year, reflecting Tweed’s present built-out production capacity. In addition, Bedrocan Canada, which became a wholly-owned subsidiary on August 28, 2015, is a Licensed Producer of medical marijuana approved by Health Canada to produce and sell its Canadian-grown, genetically identical strains of medicinal cannabis. Bedrocan Canada has been growing six proprietary genetic strains of standardized cannabis at its new production facility since February 2015. The facility is licensed to produce and sell up to 2,000kg of medical cannabis over the current domestic license period ending on February 17, 2016. Bedrocan is also licensed to sell up to 240kg of cannabis from its second licensed facility.

With a total capacity of 5,740kg, Canopy may generate maximum revenues of $43.05 million (assuming a price of $7.50/gram at full capacity). However, first-quarter revenues of $1.7 million is only reflective of operations in 12 of an eventual 30 climate-controlled indoor growing rooms at the Tweed facility, with a total of 215,929 grams sold at an average price of $7.74/gram. These production figures account for only 3.7% of the company’s production capacity – leaving the company with much room in an event that demand largely increases due to recreational marijuana legalization.

We also want to stress the fact that competition is a strong factor in this industry. Health Canada has been swamped with over 1,100 applications (as of November 2014), which is only expected to rise. Increased number of vendors will undoubtedly worsen profit margins for incumbents, as price rivalry will occur.

Alex can be reach at: alex@gravitasfinancial.com

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