I’ve always regarded publicly traded marijuana companies like Canopy Growth (NYSE:CGC) as transformative investments. Prior to the legalization movement, an equity like CGC stock would have been impossible to materialize. Therefore, an entire industry is enjoying revenue streams that simply didn’t exist several years ago.
But as much as I continue to emphasize the description “transformative,” the CGC stock price is unfortunately not cooperating. After getting off to a great start in January, shares had only extracted brief moments of upside. However, since late April, the trajectory is decidedly negative, with Canopy Growth stock shedding roughly 30%.
So what explains this mismatch between longer-term fundamental potential and the current volatility in Canopy stock? First, the company’s fiscal fourth quarter of 2019 earnings report wasn’t great. Although Canopy beat its revenue target, it widened per-share earnings losses much more than analysts expected.
However, the markets didn’t appreciate certain details. For instance, Canopy’s recreational marijuana sales were down from the year-ago quarter. So too was the volume of cannabis sold. Shortly after the disclosure, the CGC stock price tumbled badly.
And we haven’t recovered from the turmoil. For the month so far, Canopy Growth stock is down 14%.
More bad news comes in the form of revised profitability expectations. According to an interview between Jefferies’ covering analyst Andrew Bennett and Canopy’s CFO Mike Lee, CGC stock won’t be profitable in its fiscal 2020 (April 1, 2019 – March 31, 2020).
Of course, the counterargument is that we should give Canopy stock some time. However, since marijuana stocks are inherently emotional investments, the profitability downgrade represents a serious distraction.
Why You Can Still Trust CGC Stock
Before you give up on Canopy Growth stock, though, you should know that its volatility is not isolated. Other major cannabis firms, such as Cronos Group (NASDAQ:CRON) and Tilray (NASDAQ:TLRY), have faltered as well this year.
That’s not to say you should feel good about this or any other portfolio loser. Certainly, other investments’ losses have no bearing on your target asset’s decline. However, the shared fallout demonstrates that the issue is systemic rather than individualized.
And what’s causing cannabis stocks to shed so many percentage points in the markets? Mostly, it’s institutional traffic jams. Specifically, Health Canada, our northern neighbor’s department of national public health, is inundated with cannabis-licensing applications.
Unfortunately for most sector players, Health Canada will need substantial time to process all the paperwork. In the meantime, viable projects just sit, waiting for approval. Obviously, this presents a massive dark cloud on the CGC stock price.
However, I don’t expect this situation to continue without some kind of resolution. At worst, Health Canada will just roll up its sleeves and crank out the application approvals. This would mean that Canopy Growth stock would likely enjoy a delayed bull run.
But at the same time, I can envision emergency support at Health Canada. As long as those licensing applications sit, the Canadian government is needlessly throwing away cannabis-related tax revenues. Essentially, this would void the entire economic case for going green.
Moreover, the health agency’s backlog is a known headwind. While I can’t say this bearish factor has been completely priced into CGC stock, I believe we’re getting close.
If it’s any comfort, I’m putting money where my mouth is, having recently picked up Hexo (NYSE:HEXO) stock.
We’ve Seen This Before …
Another reason why I’m not panicking on names like Canopy Growth is that we’ve seen this narrative before.
Prior to Canada becoming the first G7 nation to legalize recreational marijuana, demand for cannabis stocks spiked dramatically. Again, the markets had that transformative investment idea in their heads.
But as we all know from retrospect, the investment community couldn’t support the wild valuations that cannabis firms received. As a result, marijuana stocks tumbled.
I think we’re seeing the sequel to this movie: speculators love the potential of marijuana stocks, but then they encounter an operational or other fundamental challenge (like Health Canada). Those same speculators panic out of the markets, wreaking havoc on the CGC stock price and similar investments.
However, these outside challenges will eventually fade. The Health Canada backlog is an external pressure that has nothing inherently to do with cannabis demand. If you think cannabis stocks are wild, just wait until they have a clear road ahead.
As of this writing, Josh Enomoto is long HEXO.
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