There are a lot of companies out there that I wouldn't ever even think about buying. Sometimes the growth potential just isn't there, or the stock's valuation is too high, or the risks of an investment don't seem to justify the upside. Avoiding them doesn't mean that the underlying businesses are bad, merely that it isn't the right fit for what I'm looking for.
Canopy Growth (NASDAQ: CGC) stock falls squarely within that category. Here's why I wouldn't touch it with a 10-foot pole.
It's hard to build conviction for an investment, part one
Canopy Growth's primary line of business is to sell marijuana. Its home market is in Canada, though it also has a limited presence in the E.U. and grand aspirations to enter the U.S. market. And therein lies the reasons why I will not ever buy it.
Canopy's plan to enter the U.S. market is a bit complicated.
In short, it created a parallel business, Canopy U.S.A., the point of which was to jump start the company's operations in the U.S. in advance of federal-level marijuana legalization. The U.S. organization plans to acquire Wana, Acreage, and Jetty, a trio of recreational cannabis brands. To accomplish that, on April 15 shareholders voted in favor of creating a new class of exchangeable shares. Canopy Growth will now, via a series of financial maneuvers, own a non-controlling equity interest in Canopy U.S.A.
An equity investment in the U.S. business isn't worthless. As Canopy U.S.A penetrates state-level markets, its value could grow, and full legalization would send that into overdrive. The asset on Canopy Growth's balance sheet would become larger, and it's very conceivable that its share price would rise as a result. The trouble is that the management team and shareholders of Canopy Growth do not appear to have any mechanisms that grant them actual power over the parallel company.
In other words, the investment thesis for Canopy Growth is that there could be significant gains derived from competing in the quickly expanding U.S. market despite the issue that the company has no direct exposure to the financial upsides of doing so, nor does it have any ability to control the operational details to its favor.
There's no paradox with such a thesis. It's just that it isn't a very appealing investment in light of the governance issues because there are other investments where shareholders' exposure to growth is far more direct.
It's hard to build conviction for an investment, part two
Aside from the plan to enter the U.S. cannabis market, Canopy Growth simply hasn't reported a strong performance that would motivate me to buy it. In fact, the situation is closer to the opposite. Please examine this chart:
CGC Revenue (Quarterly) data by YCharts.
As you can see, its quarterly revenue is down by 15% over the last five years, reaching $57.6 million, and in the same period, its total assets have consistently eroded away, falling by 84% to reach just over $1 billion.
This is a company that is not consistently adding to its top line, nor its bottom line. Furthermore, as it is not profitable on an operational basis, it needed to liquidate its assets, including its entire set of Canadian retail holdings, many of its cultivation facilities, and even entire brands. If you invest, you're buying a slice of a shrinking pie, and shareholders who had the most faith for a reversal and held on have lost the most.
Of course, there are a few signs of a possible turnaround. During its fiscal third quarter, its quarterly-operating losses were only $18.3 million, dramatically less than the depths of the last three years. That suggests it could start to produce more cash from its operations in the near future. And management is excited about cannabis regulations changing in markets like Germany, which could become growth centers in the future if the stars align.
But there's nothing that seems compelling enough to even start to think about making an investment until there's actual revenue growth and a clear path to becoming free-cash-flow (FCF) positive. So I won't be touching this stock today, and I doubt I'll consider it in the future either.
Should you invest $1,000 in Canopy Growth right now?
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Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
