Canopy Growth May Go Higher and Still Not Be a Buy

Canopy Growth (NASDAQ:CGC) stock is up 67% since the start of the year. And the stock continues to move higher with the cannabis company scheduled to deliver its third-quarter earnings on February 9, 2021. If the whisper number is to be believed, Canopy will deliver negative earnings per share of 10 cents on revenue of $115.75 million. If confirmed, the company will beat the consensus estimate for a bottom line of negative earnings per share of 21 cents.

Canopy is a growth stock so it’s fine to not make too much of its lack of profitability. It does however lead you to question why the stock is soaring so high in 2021. The answer to that lies in Washington D.C.

The conventional wisdom stated that a Joe Biden victory, plus (and more importantly) a Senate controlled by the Democratic party would be the catalyst for a blue wave that would pave the way for cannabis being legalized in the United States. That looks to be the case.

On February 1, a trio of senators – Chuck Schumer (NY), Ron Wyden (OR) and Cory Booker (NJ) - issued a joint statement regarding their intention to issue draft cannabis legislation “in the coming weeks.” With the Democrats in control of the Senate via Vice President Kamala Harris holding the tie-breaking vote this legislation is sure to pass.

This presents an opportunity and a problem for Canopy Growth. And it’s why investors may want to steer clear of CGC stock.

Canopy Lacks a Home-Field Advantage

A look at some simple math lays out a bearish case for CGC stock. Globally, legal cannabis sales reached $15 billion in 2019. The United States accounted for $13.6 billion of that amount. That’s 90% of legal sales flowing through the U.S.A.

And yes, the numbers for Canadian companies such as Canopy improved last year as the Cannabis 2.0 market began to take shape. But it’s clear that even without cannabis being still considered a banned federal substance, there is a huge cannabis market that Canopy is shut out of.

Making matters worse, there are a number of cannabis companies that are currently multistate operators (MSOs) in the United States. These include companies like Trulieve Cannabis Corp. (OTCMKTS:TCNNF), Jushi Holdings Inc. (OTCMKTS:JUSHF) and Curaleaf Holdings Inc. (OTCMKTS:CURLF) . They are ready and able, to scale up for what would be a surge in demand.

Canopy Has an Expensive Path to Entry

The good news for Canopy is that they do have deals in place with two MSOs that will allow them access to the U.S. market in the event a triggering event (e.g. legalization) occurs. The first of these is its acquisition of Acreage Holdings (OTCMKTS:ACRDF) (OTCMKTS:ACRHF). This includes 70.4 million Class E “fixed shares” of ACRHF that are currently valued at a $6 discount, and 30.2 million Class  “floating shares” of ACRDF that are currently trading at a 40% discount. The second investment is a contingent stake in TerrAscend (OTCMKTS:TRSSF). This $80 million payment is made up of 38.9 million exchangeable shares and 22.5 million warrants.

If (and now more likely when) a triggering event occurs, Canopy will almost immediately have a 70% controlling interest in Acreage with a minority interest in TerrAscend. However, the question needs to be asked if investors are pricing in the cost.

Canopy is not profitable and yet, if they enter the U.S. market they would likely not even reach $1 billion in sales. Yet, CGC stock has a higher valuation than the top two U.S. MSOs combined and those MSOs have a combined 2021 revenue forecast of $2.1 billion.

What to Do About Canopy Growth Stock

Let’s be clear. Investors can do whatever they want to do and right now it seems they want to bid CGC stock higher. However, if there’s one thing that the market should have made very clear by now it’s that just because a stock is being bid up higher doesn’t make it a good buy.

Canopy is still a good stock. It’s just out over its skies a bit in my estimation. And that’s the consensus opinion of analysts who have a price target of $28.23 for the stock. That’s nearly 35% lower than where CGC stock is trading. At that price, the stock looks a whole lot more appealing.

This looks like a buy the rumor, sell the news situation to me, but that’s something every investor has to decide for themselves.