Is Canopy Growth More Smoke 'N Mirrors Than A Major Contender?

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About: Canopy Growth Corporation (CGC)
by: Gary Bourgeault
Summary

Why Canopy Growth is more fragile than some of its peers.

Being a potential buy out candidate is a limiting factor in the long term.

Its temporary position as probably the leading Canadian brand in cannabis will come to an end.

Probably will outperform its peers in the short term, struggle more in the long term.

canopy growth's best days may be behind it source: newcannabisventures

It's no secret Canopy Growth (CGC) has been riding the coattails of the huge cash infusion it received from Constellation Brands (NYSE:STZ). While the cash is nice, I think the biggest benefit was the name recognition it received from the heavy media coverage it received at the time, and even since then, where most financial articles continue to point out the past event.

In this article I want to examine the strong probability that the company has peaked with the value of its connection to Constellation Brands, and will now have to battle it out in relationship to branding and production capacity with some of its major peers.

Is the company fragile?

In his book "Antifragile," Nassim Nicholas Taleb talks about the fragility of people, organizations or institutions when steps are taken to eliminate stressors in life that help to build resistance against the inevitable challenges that accompany life. His conclusion was that not embracing certain types of stressors actually make, in the case of an organization or company, fragile to unexpected major cataclysmic events called Black Swans that could end up destroying a company.

The point of that as it relates to Canopy Growth is that the benefits it has received from Constellation Brands, as beneficial as they look from the outside, has in my view, removed the benefit of some stressors from the company, which I think has made it more vulnerable than some of its peers to unexpected major challenges. It also has, in my opinion, made the company more lethargic concerning its growth.

The company has received a lot of sizzle from its partnership with Constellation, but on the deployment of its capital, there hasn't been a lot of steak. I get the feeling the company, because of the infusion of billions in capital, is playing it safe; biding its time until it is probably fully acquired by Constellation, or at least until it controls over 50 percent of the company.

Why I'm not impressed with the buyout factor

A number of investors that are favorable to Canopy Growth over most if not all of its peers, push the expected acquisition of the company by Constellation. While that would be a positive for short term gains as directly related to shares owned in the company, I'm not convinced it's a positive for the long term.

The major reason for that is it puts a cap on the ceiling for the company. What the actual cap will be would be determined by its value at the time of the acquisition, but the fact remains it'll be a cap that will limit the long-term growth potential of Canopy if it were to remain a standalone company.

After all, how many long-term investors would find the company compelling after it was absorbed into Constellation and just becomes another one of its units?

As mentioned earlier, I see this as a negative in the sense it puts the company in the place of taking a safer route than say, some its more aggressive peers like Aurora Cannabis, which has rapidly surpassed it in production capacity.

My thought is Canopy is acting far too much like a mature company than is warranted at this time, and has lost some of its competitive edge it had in the early years. This is part of the antifragile element I mentioned earlier; in the form of what I consider a major event where one of its major competitors quickly overtook it on the supply side of the business, it points to the fragility of the company because of its heavy reliance on Constellation Brands and its capital.

Even now we're already hearing rumblings of dissatisfaction from Constellation shareholders that consider Canopy a weak investment because of the heavy debt load it added to the company. This actually masks the weakness of Canopy, because if it is acquired by Constellation, it will be exposed to the debt load as a consequence of the prior deals, but it would also be further exposed to what it would cost to take a dominant position in the company, or to buy it outright.

Branding lead will dwindle

Branding is considered to be one of the more important competitive advantages over the long-term for the cannabis industry in general, and I see the temporary lead held by Canopy Growth starting to erode.

This goes back, once again, to the partnership it has with Constellation Brands, which generated so much free advertising for the company, which in turn catapulted it from a branding standpoint, into the market lead. I think it retains that lead, but as more investors research the cannabis sector, that will without a doubt start to shrink.

I'm referring to the overall brand of the company here, not its vertical brands that could emerge in various sectors of the cannabis industry. It does have Tweed, but for now I don't see that as being much of a branding factor at this time.

The reason for that is the market in Canada is experiencing a shortage of supply, which means end users want product at this time, not a specific brand. This is actually detrimental to Canopy Growth in my view because those supplying cannabis can position it as a brand in the minds of customers, and take away the little branding advantage Canopy still retains.

Based upon its recent performance against its major competitors, it appears Canopy is still the leading brand; but I see that weakening in the not-too-distant future because of the demand that opens the door for competitors to build relationships with distributors and direct customers that allow for brand-building to occur.

Conclusion

I think Canopy Growth has a little room left in the sun before it is pushed aside to secondary status among the major players in the industry; by which I mean some of its Canadian peers.

While it does have a cash advantage and the benefit of the cash infusions it received from Constellation, it hasn't translated into taking aggressive steps to widen its lead over competitors. I think the company and shareholders are going to regret that it didn't take a terrific opportunity to do so when it could.

I believe this is the weakness that management at Aurora Cannabis saw, and why it has been so aggressive in buying up quality assets to move into the market lead on the production side of the business, even as it quickly expands its international operations.

For now, I think Canopy Growth shareholders will continue to be rewarded for their positions in the company, but I see it as more of a short-term benefit now, as it looks like the company is positioning itself for an eventual takeover by Constellation Brands rather than taking more aggressive steps to grow.

I think the Constellation Brands advantage is winding down, and the market is now rewarding Canopy Growth for its buyout potential rather more than its performance. For the more risk-averse investor this isn't necessarily negative, but the top end of its potential looks to be slowing down, and with the still inherent risk in the cannabis industry in general, it makes the risk/reward factor less appealing to me.

Canopy Growth remains a good short-term play, but I'm starting to like some of its major competitors much better over the long term.

The key thing to decide now is whether or not Constellation Brands will be a good long-term holding, as it is almost certain it will eventually acquire over 50 percent of Canopy, or possibly all of it.

Disclosure: I am/we are long ACB.

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.