When the year began, expectations for the cannabis industry were off the charts — and the performance of pot stocks during the first quarter confirmed it. The Horizons Marijuana Life Sciences ETF, the first cannabis-focused exchange-traded fund, galloped higher by more than 50% in the first quarter, with over a dozen popular cannabis stocks gaining in excess of 70%. With Canada having legalized recreational marijuana in October 2018 and the U.S. seemingly adding new legalized states each year, the sky looked to be the limit..
Little did investors know that the “sky” had a low-hanging glass ceiling.
One of the most popular marijuana stocks has a new fan on Wall Street
Since the end of the first quarter, marijuana stocks have been pummeled, with a capital “P.” Most are down in excess of 50%, with the largest pot stock in the world, Canopy Growth (NYSE:CGC), losing more than $10 billion in market cap and close to 70% of its share price since finding its highs earlier this year. But this decline has some analysts on Wall Street considering cannabis stocks a good value.
Last week, on Wednesday, Nov. 20, Bank of America/Merrill Lynch covering analyst Christopher Carey upgraded Canopy Growth to buy from neutral and set a 24 Canadian dollar price target ($18.04). Interestingly enough, Carey and his team at BofA/Merrill Lynch had cut Canopy from buy to neutral less than two months prior, while setting a CA$27 target.
In the research note released to clients, Carey stated that Canopy Growth’s stock had dropped 38% since issuing the downgrade on Sept. 27. Since then, valuations have become more reasonable, with sales estimates coming down and becoming achievable, if not beatable. BofA also points out that inventory levels are becoming leaner, which may help to alleviate early stage oversupply and pricing pressure concerns.
Even with Canopy’s valuation significantly reduced, it remains the largest marijuana stock by a mile, and is clearly one of the most popular among investors. But just because one Wall Street analyst sees greener days ahead does not mean this stock is worth buying.
This Wall Street buy recommendation is very premature
For one, there doesn’t seem to be much hope of Canada’s supply problems resolving anytime soon. Health Canada has changed its cultivation application process to hopefully approve more growing licenses, but is still contending with a huge backlog of cultivation, processing, and sales license applications.
The bigger worry on the supply front for Canopy is that certain provinces haven’t done a very good job of providing sales channels for legal weed. Ontario, a province of 14.5 million people (nearly 40% of Canada’s population), had just two dozen open retail locations a full year after the launch of recreational marijuana. That’s simply not going to cut it, and it’s creating an odd situation whereby growers are facing oversupply, yet most consumer demand is still being met by black-market producers. It’s already difficult to drive out black-market producers with legal product facing an excise tax, but it’s considerably tougher when regulatory agencies are slow-stepping the rollout of dried cannabis flower and derivatives.
Another issue for Canopy Growth is that the company’s aggressive overseas investments aren’t anywhere near a point where they’re going to pay dividends. Health Canada is counting on growers to satisfy domestic demand before shipping substantial amounts of cannabis to overseas markets, and Canadian supply issues are unlikely to be resolved for a while. Also, a number of overseas countries are still in the process of establishing their medical marijuana regulations, suggesting that they’re nowhere near the point of accepting bulk imports from Canopy…
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