Medical Marijuana Producer Canopy Growth – Undervalued Or Overvalued?

by Trefis Team
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With all the excitement around legalization of marijuana for recreational purposes in Canada, pot stocks in the country are having a gala time. Investors are rushing to buy these stocks to generate early returns from the newly opened recreational marijuana market, causing these stocks to witness a surge in their market value. However, it is becoming increasingly difficult to choose which Canadian marijuana stock has the potential to deliver the maximum return in the coming years. Thus, in this note, we discuss Canopy Growth (NYSE:CGC) (TSX:WEED), the front-runner in the Canadian cannabis market, and how it still has an upside despite investors believing it to be overvalued.  You can view our Forecast for Canopy Growth interactive dashboard and create scenarios to match your assumptions.

Overvalued?

Canopy Growth is a Canadian medical marijuana company, producing and selling medical cannabis within the purview of Canadian laws. It is listed on the New York Stock Exchange (NYSE) and the Toronto Stock Exchange under the ticker CGC and WEED respectively. The company is now exporting its cannabis output to jurisdictions outside of Canada, such as Europe, Latin America and the Caribbean, where it is federally lawful and regulated. The company also has a partnership whereby Constellation Brands (NYSE: STZ) has a 9.9% stake in the company.

As per consensus estimates, Canopy Growth’s 2018 revenue is expected to reach over CAD 79 million, which is double of what it generated in 2017. This will be largely driven by the continued growth in the demand for medical cannabis products within Canada, coupled with improving pricing for these products. Based on these estimates, the company’s 2018 price-to-sales (P/S) multiple is close to 89x. This number seems unreasonably high for any company, making one believe that the market is severely overvaluing the company.

Undervalued!

However, looking at the changing scenario in Canada, where adult-use of marijuana will become legal from 17th October 2018, the multiple may not seem that rigorous. This is because, according to industry experts, the sales of Canadian marijuana are expected to go up by more than $4 billion in the first year of legalization for adult-use [1]. This indicates that the opening of the recreational marijuana market will open up new avenues for Canopy to grow and justify its current valuation.

Given the huge market potential, the company is making all efforts to capitalize on the vast opportunity that the newly opened recreational marijuana market may offer. Currently, the company operates facilities with over 2.4 million square feet of growing space. However, in order to cater to the anticipated rise in demand for its cannabis products, the company has plans to expand its operations to more than 5 million square feet of growing space by the end of next year. This will allow Canopy to produce in excess of 750,000 kilograms of cannabis each year at full capacity. This is significantly large compared to its Canadian competitors Aurora Cannabis and Aphria. Thus, it is fair to assume that the company is well-equipped to meet the growing demand for its cannabis products starting October of this year. In fact, Canopy has already secured supply agreements for recreational marijuana with three provinces in Canada and has announced retail sites in Saskatchewan, Newfoundland and Labrador.

In addition to this, Canopy recently announced the addition of well-respected cannabis industry veterans – Kirk Tousaw and Mat Beren – to its West Coast bench. The two will provide consulting services and collaborate with the company to enhance the quality of its products while supporting advocacy and community engagement. This is be an added advantage for Canopy, since advocacy and quality are crucial in the cannabis industry.

Additional Upside

Apart from the recreational marijuana market, Canopy is also targeting to expand its operations in international markets. At present, there are around 22 countries outside of Canada that have legalized medical marijuana and many more countries are considering the move over the next few years. This implies that there is massive growth opportunity for the company if it can enter into these markets ahead of its competitors. To this effect, Canopy has already expanded its operations to federally legal markets in Australia, South Africa, South America and Europe. This first mover advantage will allow the company to establish its dominance and become a leader in these markets.

Thus, based on the above discussion, we figure that despite trading at a very high P/S multiple, Canopy Growth has a huge upside potential, given the opening up of the recreational marijuana market. Further, the company’s efforts to expand in international markets will have a positive impact on the company’s long term value. We will closely watch the company’s 4Q’18 results that are likely to be announced on 27th June 2018.

Do not agree with our forecast? Create your own price forecast for Canopy Growth by changing the base inputs (blue dots) on our interactive platform.

 

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Notes:
  1. Legal marijuana could spark a $4 billion industry in Canada, CNN Money []
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