When the curtain closes on 2018, there's a very good chance it'll go down as the most productive and progressive year in history for the legal marijuana industry.
One of the biggest events of the year is set to take place in less than eight weeks. On Oct. 17, Canada will officially lift the gate on recreational marijuana sales to adults. Once legal, sales are expected to soar, with the industry pulling in up to $5 billion in added annual sales when fully ramped up. The expectation of billions of dollars in added revenue is what's coerced investors to dive headfirst into marijuana stocks.
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Aside from Canada legalizing adult-use weed, we've witnessed over-the-counter-listed pot stocks uplist to reputable exchanges, observed as a traditionally Republican-leaning U.S. state approved medical cannabis, and stood in awe as the U.S. Food and Drug Administration gave the green light to the very first cannabis-derived drug. It's truly been a banner year.
Canopy Growth has surpassed these time-tested companies in market cap
Still, lost among all of these "marijuana firsts" is just how large some of the top-tier marijuana stocks have grown, in terms of market cap. The largest marijuana stock of all, Canopy Growth Corporation (NYSE: CGC), was making waves earlier this year when it was nipping at a nearly $4 billion valuation -- an almost unthinkable market cap without knowing if the Cannabis Act would be passed in Canada. Yet, as of market close on Aug. 20, Canopy Growth had a market cap of $8.4 billion.
Though much of its recent surge in market cap is a result of Corona and Modelo beer owner Constellation Brands taking an additional equity stake of $3.8 billion in the company at a 51% premium to the closing price prior to the investment announcement, the fact of the matter is, Canopy Growth is now larger than a number of time-tested companies. Here's just a small sampling of more than 100-year-old, highly profitable businesses that are now looking up at Canopy Growth Corp. in the market-cap column:
- Harley-Davidson: American motorcycle kingpin Harley-Davidson (NYSE: HOG), which was founded 115 years ago, has recently drawn the ire of President Trump for its decision to move some of its production to foreign markets as a result of tariffs increasing material costs. As a result, Harley-Davidson's shareholders have taken a licking, with the company's market cap now clinging to the $7 billion mark.
- Foot Locker: Known as the one-stop-shop for brand-name footwear and accessories, Foot Locker (NYSE: FL) and its $6.1 billion market cap now look up to Canopy Growth. Foot Locker, which was founded in 1879, had over 3,300 operating locations as of February 2018.
- Xerox: Founded in 1906 and best known for its copying machines decorating practically every office regardless of size, Xerox (NYSE: XRX) today is carrying around an approximate $7 billion market cap. Despite its efforts to shed its image as a purveyor of outdated technology, Xerox now looks up to a marijuana stock in the market-cap column.
- Whirlpool: Like Harley-Davidson, appliance maker Whirlpool (NYSE: WHR) has been hammered by tariffs as of late, which has wreaked havoc on its stock. In spite of having 110 years of operating history under its belt, Whirlpool's most recent quarterly stumble has pushed its market cap down to $8.3 billion, just below that of Canopy Growth.
Canopy Growth has some big expectations to live up to
Understandably, there's some cherry-picking involved, here. For instance, trying to compare the rapidly expanding cannabis industry (which could see triple-digit growth for a couple of years in Canada as the supply chain ramps up) to, say, Xerox, which is traditionally a low- to mid-single-digit growth business, is comparing an apple to an orange.
However, there's no denying the head-scratching that ensues when looking at the consistent profits that Harley-Davidson, Foot Locker, Xerox, and Whirlpool bring to the table when compared to Canopy Growth's still nascent top-line figure and widening net loss, as of its most recent quarter.
Here's a quick breakdown of how much net income these time-tested businesses have generated over the trailing-12-month period, according to Yahoo! Finance:
- Harley-Davidson: $494 million
- Foot Locker: $269 million
- Xerox: $101 million
- Whirlpool: minus $555 million (includes a number of one-time charges)
With the exception of Whirlpool, which took an $860 million non-cash asset impairment charge in the second quarter, these time-tested businesses are churning out big profits. Whirlpool's five-year average per-year profit is $661 million. Meanwhile Harley-Davidson, Foot Locker, and Xerox have churned out respective five-year average profits of $706 million, $504 million, and $430 million.
Where's Canopy Growth Corp.? Well, it hasn't turned a full-year profit as of yet. In fact, its fiscal first-quarter operating results show a more than sixfold increase in its per-share loss, with its net loss widening to 90.8 million Canadian dollars ($69.6 million). Despite an expected 310% increase in sales this fiscal year, Canopy Growth is projected to lose money.
Strong profitability is no assured thing
The truth of the matter is that Canopy Growth isn't assured of big profits, even if it's ahead of the field in terms of distribution channels, partnerships, and production capacity.
The biggest issue that could plague marijuana stocks like Canopy Growth is the uncertainty that surrounds the supply-and-demand outlook.
An initial shortage appears likely given that growers had to wait until the Cannabis Act was sure to pass before spending on capacity expansion projects. While this should result in a higher per-gram cannabis price, growers aren't going to be able to take full advantage of it since their production will still be ramping up. When production is fully online, states like Colorado, Washington, and Oregon suggest that growers will grossly overproduce and tank the per-gram price for dried cannabis, thusly hurting margins. It could take years for the marijuana supply and demand to find harmony, which could mean weaker-than-expected sales and/or profits.
Additionally, there aren't any guarantees that the legal market will be able to pull enough sales away from the illegal channels to meet investors' lofty expectations. Even though Canada's federal government is being aggressive by setting a relatively low excise tax rate of roughly 10% on recreational weed, investors have to remember that black-market marijuana has no excise tax to pay, no marketing or packaging costs to incorporate, or rent to pay via a licensed dispensary. It could be very difficult for legal weed to compete with illicit pot, which may throw Canopy Growth's sales estimates into doubt.
Clearly, there's still a lot for Canopy Growth to prove to Wall Street and investors, which makes this a stock that could be worth avoiding for the time being.
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