Sell Canopy Growth - Extreme Overvaluation, Questionable Accounting Assumptions


  • Canadian cannabis stocks have seen a surge in value over the last twelve months, in anticipation of federal legalization. Fundamentals have lagged the massive share price appreciation for these companies.
  • Bulls cite an untapped industry with pent-up demand in which legalization will open the floodgates with cash flow soon to follow. I disagree and see oncoming headwinds for Canopy Growth.
  • My experience as a consultant in the now-legalized cannabis markets of California and Oregon suggests a tough road ahead for the Canadian operators.
  • I also question the accounting used to arrive at the value of Canopy's biological assets and the valuation that market participants are willing to pay for the common stock.
  • Canopy Growth Corporation is a strong sell.

Investment Thesis

The pending legalization of cannabis in Canada has caused a massive inflow of speculative money into Canadian cannabis stocks, and valuations across the board are frothy. Canopy Growth Corporation (NASDAQ:CGC), the largest pure-play publicly-traded cannabis company, is priced beyond perfection, and investors deploying capital at current valuations will very likely face long-term losses.

The price of a pound of trimmed buds has dropped immensely in US locales that have legalized, and this drop has hurt growers the most. With so many producers competing with a similar quality product, cannabis has become a commodity in these regions, and wholesale prices have fallen sharply. When recreational pot becomes legal in Canada, I anticipate that prices will fall and producers will bear the brunt of the pain.

Canopy also has its own set of financial issues: an unreasonably high stock-based compensation expense resulting in continued dilution, and questionable accounting assumptions used to calculate inventory value (changes which come through to the income statement "mark-to-market").

The company is also overvalued on every metric even as it continues burning cash at an accelerating pace. Market participants desperate for exposure to cannabis have bid the equity price so high that the valuation has no fundamental basis.

I believe an investment in Canopy today is akin to investing in Cisco (CSCO) or Microsoft (MSFT) at the very peak of the dot-com bubble - when this bubble bursts, investors could wait years before seeing a reasonable return on their capital, if ever at all.

Stunting the Growth Story

Canopy Growth Corporation engages in the production, possession, and sale of cannabis in Canada. The company also invests in outside ventures in jurisdictions where marijuana is federally legal, which for now includes parts of Europe, Latin America, and the Caribbean.

Canopy Growth has an extremely frothy valuation as


CGC PS Ratio (TTM) data by YCharts


CGC Cash from Operations (Quarterly) data by YCharts

This article was written by

High conviction investment ideas in the winners of tomorrow.

I currently collaborate with Julian Lin for his marketplace service, Best of Breed Investors. We study and select companies who are leaders in their industries, have best-in-class management teams, and opportunities for continued growth. But just as importantly, we identify and avoid poor-quality or poorly managed companies which have the potential to weigh down on a portfolio's returns.

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-Posts from this account are for informational or entertainment purposes only. Investors should not interpret posts from this account as investment or tax advice. Please consult a paid professional for tax or investment advice. As an occasional trader, I may have positions in any stocks I discuss unless specifically disclosed. Investors are expected to do their due diligence before starting a position in any of the securities discussed on this profile.

Disclosure: I am/we are long CSCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no position in CGC, long or short.

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