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Why Canopy Growth Is Up 42% So Far in 2018

Dan Caplinger, The Motley Fool

It's hard to find fault with a stock that's absolutely crushing the market so far this year. Yet for investors in Canopy Growth (NYSE: CGC), even a rise of more than 40% is a bit of a letdown when just a month ago, the well-known marijuana stock had posted year-to-date gains of 140% -- making it one of the best performers in the budding crop of high-profile marijuana stocks.

Canopy has seen its stock follow a similar trajectory to that of some other top players in the industry, but it's also found ways to differentiate itself from the crowd. In particular, Canopy's collaboration with Constellation Brands (NYSE: STZ) has given the cannabis company a level of credibility among mainstream investors that most other marijuana upstarts lack. Even though disappointing downturns are inevitable, Canopy's likely in a better position to benefit from long-term growth in marijuana than many of its competitors are.

CGC Chart

CGC data by YCharts.

A deepening relationship

Canopy Growth came into 2018 riding high on enthusiasm from the cannabis company's initial deal with Constellation Brands. Under the terms of the late-2017 agreement, Constellation took a nearly 10% stake in Canopy in exchange for about 245 million Canadian dollars in cash. At the time, Constellation CEO Rob Sands singled out Canopy as a high-quality business, noting that it had "a seasoned leadership team that understands the legal, regulatory and economic landscape for an emerging market that is predicted to become a significant consumer category in the future."

Throughout much of the year, Canopy made incremental progress in building up its business. In its financial reports, Canopy noted that although losses mounted from money spent on ramping up marketing activity, sales stayed on a steady upward slope. Fiscal first-quarter results that were announced in August showed that quarterly revenue was higher by 63% year over year, including a 14% rise compared to the previous quarter three months earlier. Especially encouraging was the fact that Canopy managed to increase its average selling prices on a per-gram basis, emphasizing sales to high-profit markets like Germany as well as focusing on selling cannabis-derived oil products and commodity dry cannabis. Yet the marijuana company's steady gains failed to show up in its stock price.

Stats on Canopy Growth

Revenue, Past 12 Months

CA$93.7 million

1-Year Revenue Growth

62%

Net Income, Past 12 Months

(CA$477.4 million)

Year-Ago Net Income

(CA$19.4 million)

Source: Canopy Growth.

That all changed in mid-August, and a big part of the boost that Canopy Growth got came from an even deeper commitment from Constellation Brands. The beverage giant chose to invest another CA$5 billion in Canopy, giving it the potential to take its stake in the marijuana company to 38% as well as opening the door to Constellation's eventual majority control of Canopy if it so chooses. By putting a price tag of CA$48.60 per share on Canopy stock -- about $37 in U.S. dollars -- Constellation paid a huge premium and made clear that the marijuana company was its pick as the early leader of the cannabis industry.

Canada's launch and the rise and fall of marijuana stocks

At the same time, investors grew extremely excited about the impending legalization of recreational cannabis in Canada in mid-October. Given the vote of confidence from Constellation, Canopy participated in that upward move, albeit not to the same extent in percentage terms as some of its smaller industry peers did.

Worker wearing Tweed uniform, hairnet, and gloves working on a cannabis plant in a white room.

Image source: Canopy Growth.

Canopy proved equally vulnerable when the hype over the Canadian rollout gave way to reality. Despite ongoing strategic moves to build new partnerships, expand its production capacity, and work on developing export capacity internationally, Canopy stock fell by almost a quarter in October alone.

What's ahead for Canopy Growth?

Despite some disappointment following the release of Canopy Growth's fiscal second-quarter results, the cannabis company has made huge progress toward most of its strategic goals. Canopy's Tweed brand is capturing substantial market share in the Canadian recreational rollout, and the company's plans to build out proprietary retail store locations could pay off in the jurisdictions that are allowing companies to differentiate themselves in that manner. The company's emphasis on high-margin products is also serving it well, even though some investors haven't been able to get past the negative impact on sales volume growth that Canopy's restraint has had. Rather than trying to boost volume of low-margin commodity products, Canopy's more aware of the need to build itself up as a high-quality brand-name provider of cannabis to consumers with more discriminating tastes.

It's too early for Canopy Growth to declare victory in its efforts to take a lasting leadership position in the marijuana space. Yet with Constellation at its side, Canopy has a lot going for it, and shareholders hope they'll continue to share in the long-term gains that the cannabis company produces in the future.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.