Why I think Canopy Growth’s best days are still ahead

Powder of Cannabis (Drugs), Analysis of Cannabis in laboratory.
Powder of Cannabis (Drugs), Analysis of Cannabis in laboratory.

This article was originally published on Fool.com

Investors are flooding into cannabis stocks, and plenty of companies that hardly anyone had ever heard of just a year ago have now become some of the best-known names in the marijuana space. Canada’s legalization of recreational marijuana has pulled stocks that operate north of the 49th parallel into the spotlight, and Canopy Growth (NYSE:CGC) has become one of the early-moving leaders of this budding industry.

Many think that Canopy Growth’s best days might well be behind it. After all, the stock has already seen shares jump more than 20-fold on the Toronto Stock Exchange since mid-2016, and it’s posted impressive gains in the few months that it’s traded on the New York Stock Exchange as well. But thanks in large part to a nearly $4 billion investment from Corona beer maker Constellation Brands (NYSE:STZ) as well as its own strategic vision for marijuana dominance, the future for Canopy Growth still looks bright.

Worker wearing gloves and hair net working on cannabis plant.
Worker wearing gloves and hair net working on cannabis plant.


What Canopy can do on its own

Even before Constellation upped the ante by boosting its stake in the marijuana grower, Canopy had a number of things going for it that gave it a competitive advantage over most players in the industry. Canopy already has huge production capacity, having reported about 2.4 million square feet of licensed growing space for cannabis as of mid-2018. Moreover, the company is investing heavily in boosting production, with new greenhouses in key areas like British Columbia potentially more than doubling its square footage to a goal of 5.7 million square feet. Once fully online, that could bring Canopy’s dried cannabis production capacity into a range of roughly 450,000 to 500,000 kilograms, and that would leave it as either the industry leader or a close second based on current planned investments elsewhere in the sector.

Moreover, unlike many cannabis companies, Canopy was smart early on in recognizing the value of diversifying its geographical scope. Rather than simply building distribution networks in Canada, Canopy already has a presence in several foreign markets, and the ability to export cannabis gives the company the ability to avoid price challenges in its home market to find the best profit opportunities worldwide.

Canopy has also seen the importance of building a brand. The company’s Tweed line of products goes well beyond dried marijuana leaf to encompass growth areas like softgel capsules for cannabis-derived oils. And even under Canada’s plain-packaging laws, Tweed has the ability to develop a loyal customer base that will give Canopy the ability to market value-added products with higher margin levels than plain dried cannabis.

Canopy and Constellation

Yet the biggest vote of confidence in Canopy Growth has come from Constellation Brands. The alcohol specialist has made multiple investments in Canopy, starting with a nearly 10% stake a year ago for $190 million and then doubling down with its $3.8 billion deal this past August. Under the terms of the deal, Constellation not only boosted its interest in Canopy to 38%, it also gave itself the option to boost its stake in Canopy if it chooses to exercise its rights on warrants and convertible debt to accept additional shares of the marijuana producer.

The opportunities for Canopy and Constellation to collaborate have huge potential. A number of companies are already exploring the potential for beverages that incorporate various cannabis-derived oils, emphasizing both the positive health impacts of certain types of oils and the popularity of cannabis in general. Just as energy drinks reinvigorated a flagging market for traditional sugary carbonated soft drinks, so too could marijuana-containing beverages bring new interest to the industry.

Constellation also likely sees the collaboration as a defensive measure. Some cannabis advocates have played up the advantages of marijuana over alcohol. If consumers substitute cannabis for beer and spirits, then it’s useful for Constellation to have exposure to both industries — while still potentially leaving Canopy stock available for investors who want purer exposure to the cannabis sector.

A play on innovation

Finally, Canopy understands that it needs to foster innovation in order to stay ahead of the game. That’s a big part of why it funded the Canopy Rivers investment vehicle, and already, it’s found some lucrative investments that could pay off for Canopy Growth in the future.

Canopy Growth has already seen impressive gains for early shareholders, and it’s reasonable for investors to highlight both risks and potential rewards from investing in the stock. Yet from a fundamental business perspective, the best days for Canopy Growth lie squarely in front of it.

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