We are coming up on the one year anniversary of the nationwide legalization of cannabis in Canada. In that year, shares of Canadian cannabis leader Canopy Growth (NYSE:CGC) have been on a roller coaster ride. Canopy Growth stock shot out of the gates, fully loaded with guns blazing, in late 2019.
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Canopy had scored a big, multi-billion dollar investment from alcoholic beverage giant Constellation Brands (NYSE:STZ), leveraged that investment to obtain more growing capacity than peers, and from day one, captured about 30% of the Canadian cannabis market.
In response, CGC stock soared from $25 in July 2018, to over $50 by October.
Canopy Growth stock has since swung violently between $25 and $50 over the past several months. In late 2018, CGC stock dropped towards $25 as global growth concerns weighed on what was unchecked optimism in the cannabis space.
Then, in early 2019, CGC stock roared higher as the company made promising international expansion moves, especially in the U.S. Since, the stock has tumbled, mostly because the company’s growth ramp in Canada has meaningfully slowed in 2019.
Net net, it’s been a wild year for CGC stock. What’s next?
I think the next big move in CGC stock is likely to be a rally back towards $50. Why? Three big reasons. Those three reasons are as follows.
Capacity Build-Out and Sales Growth
The first big reason to believe that CGC stock could rally back towards $50 over the next few quarters is that the company is laying the groundwork for re-accelerated sales growth by rapidly expanding growing capacity.
Specifically, despite sluggish and disappointing sales trends recently, Canopy Growth has managed to substantially increase its growing capacity during this slowdown. Last quarter, Canopy’s harvest measured around 41,000 kilograms – up nearly 200% sequentially and over 300% year-over-year, and by far away the biggest harvest of any Canadian cannabis company.
Since then, the company has only increased growing capacity. They just won an extraction license for a new facility in Saskatchewan, which is expected to come online in Fall 2019 and extract around 5,000 kilograms of hemp a day.
Broadly, then, Canopy is rapidly increasing their growing capacity. Ultimately, this ends with Canopy having a lot more supply than all of its competitors, which results in Canopy selling a lot more weed than all of its competitors, too.
Big picture – Canopy’s sales trends are slowing right now, but huge growing capacity expansions imply that this slowdown will be replaced by acceleration pretty soon.
Rec 2.0 Will Create A Rising Cannabis Tide
The second big reason to believe that CGC stock could rally back towards $50 over the next few quarters is that the legalization of cannabis 2.0 products will create a rising tide across the whole cannabis industry that should lift all boats.
Specifically, in late 2019, Canada is set to introduce a whole new portfolio of cannabis products into the legal market, including edibles and vapes, which are two of the most popular ways to consume cannabis. The introduction of these new cannabis products will increase the legal market’s reach, broaden demand and interest, and ultimately grow the market. This broad market growth should provide a rising tide which lifts all boats.
Further, because of the company’s huge capacity build-out, Canopy Growth could actually be a huge winner with rec 2.0. Just consider, at the same time that a slew of new cannabis products are months away from coming to market, Canopy is aggressively building out their cannabis supply.
That combination ultimately implies that Canopy is gearing up to sell a bunch of rec 2.0 cannabis, meaning growth rates in 2020 could look a lot prettier than they do today.
Gross Margins Will Improve Meaningfully
The third big reason to believe that CGC stock could rally back towards $50 over the next few quarters is that gross margins are set to improve meaningfully.
Canopy’s gross margin performance to-date has been disappointing. This was once a 40%-plus gross margin business. Over the past few quarters, gross margins have dipped into sub-20% territory as the company has emphasized capacity build-out and retrofitting. But, this capacity build-out won’t last forever.
Instead, it appears that the bulk of this capacity expansion is over. If so, then overall gross margins will improve meaningfully over the next few quarters, since gross margins last quarter ex capacity and retrofitting impacts were around 32% – versus the reported 15%.
Further, management plans to start optimizing their growing facilities soon. That will provide a lift to gross margins, too. Even further, rec 2.0 cannabis products carry a higher gross margin, so that will provide another lift to gross margins.
At the end of the day, management is pointing towards 40% gross margins by the end of fiscal 2020, and the fundamentals make it seem like that target is entirely doable. Thus, over the next four quarters, gross margins have potential to go from 15% to 40%. That’s a big enough uptake to provide a meaningful tailwind for Canopy Growth stock.
Bottom Line on Canopy Growth Stock
CGC stock has been through turbulent times. It’s unlikely that this turbulence will subside any time soon, but turbulence is a double-edged sword. It means big drops and big rallies. The next move in Canopy Growth stock will likely be a big rally, so taking advantage of the turbulence and buying Canopy Growth on this dip seems like a smart move.
As of this writing, Luke Lango was long CGC.
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