Well-known Canadian pot company Canopy Growth (NASDAQ:CGC) has been holding its ground despite sectorwide hurdles for the past few years. While the coronavirus pandemic did boost marijuana sales in both the U.S. and Canada, that wasn’t enough for Canopy to make a profit, in part because regulatory hurdles in Canada are still delaying the opening of legal stores. That said, things seem to be improving now.
Moreover, Canopy’s strong partnership with U.S. beverage giant Constellation Brands (NYSE:STZ) has been keeping its pockets deep enough to survive any crisis.
That said, the company did have to make some harsh cost-cutting decisions recently under new CEO David Klein to reduce operating expenses. But all hope is not lost for Canopy. Its stock is up 27% so far this year, versus the Horizons Marijuana Life Sciences ETF‘s gain of 63%. The company is making a mark with its cannabis derivatives products, beverages in particular, and management believes they can dominate that market. Let’s take a look at its progress and determine whether this pot stock is a worthwhile investment for the long term.
Cannabis beverages could give the alcohol industry a challenge
Experts believe cannabis beverages could soon be moving in on the alcohol industry. Drinkable cannabis is an entirely new and different form of the drug — one of the “derivative” forms Canada legalized in October 2019 as part of “Cannabis 2.0” — and many customers who do not like the traditional method of smoking cannabis are using derivatives as a substitute (including vapes, chocolates, edibles, concentrates, and more).
The global marijuana beverage market is expected to grow at a compound annual growth rate (CAGR) of 18% to reach $2.8 billion by 2025, according to Grand View Research. Leading the beverage market could turn out to be a plus for Canopy.
But peers are catching up
Canopy had an early mover’s advantage with derivatives that allowed it to capture a good chunk of the beverage market in Canada. It has already successfully become the market share leader in the cannabidiol (CBD)-infused ready-to-drink beverages category in Canada, according to management, and its beverages captured 34% market share in the third quarter.
The only company besides Canopy that’s launched cannabis beverages is peer HEXO. But it appears that Aphria (NASDAQ:APHA) is getting ready to give Canopy a tough fight. That company recently acquired U.S. craft brewer SweetWater Brewing Company as a way to enter the cannabis beverage segment when federal legalization takes place. While it has yet to launch any products, Aphria plans to get started even before legalization, leveraging SweetWater’s innovative expertise with its craft beers and other beverages to introduce its own brands to the market. Aphria also intends to sell SweetWater’s 420 brand and other beverage offerings in the Canadian sector. All that said, despite the competition, Canopy still holds the top three brands in the beverage marketplace.
The U.S. derivatives market has tremendous potential beyond beverages, but Canopy cannot make a mark here until the status of legalization changes. And when that does happen, Canopy could also face tough competition from its U.S. counterparts, which are ramping up their production for derivatives.
But Canopy has an upper hand thanks to Constellation and another U.S. partner, Acreage Holdings, which also has networks in the U.S. that can help it dominate in the beverage category. Constellation invested 245 million Canadian dollars ($191 million) in Canopy in October 2017 and currently holds a 38.6% stake in the company, with the right to acquire more if it chooses to exercise its warrants. In April 2019, Canopy entered into an agreement to acquire U.S.-based hemp company Acreage Holdings. However, Canopy and Acreage’s partnership is contingent on the federal legalization of marijuana in the U.S.
While Canadian companies cannot legally introduce products with tetrahydrocannabinol (THC, the psychoactive compound found in cannabis) in the U.S., no such restriction exists for the non-psychoactive compound cannabidiol (CBD). To take advantage of this, Canopy recently made an entry into the U.S. CBD beverage market, launching Quatreau, a premium ready-to-drink CBD-infused sparkling water, with partner Acreage. This product will be sold online for now before it is launched in retail stores. We will have to wait and see how U.S. consumers respond to Canopy’s strategy of no-THC, low-calorie beverages.
Canopy Growth’s future looks bright
Even though Canopy hasn’t achieved positive EBITDA (earnings before income, tax, depreciation, and amortization) yet, it shouldn’t be long before its efforts start showing results. Constellation’s backing is one big advantage: Having access to cash is helping Canopy sail through the rough waters smoothly, while other companies like Aurora Cannabis are battling to survive. Canopy’s recent Q3 fiscal 2021 results are proof of that. Its net revenue jumped 23% from the year-ago period to CA$153 million — not a drastic increase, but it is steadily growing, which helped reduce EBITDA losses in the quarter. A 15% year-over-year dip in total SG&A (or selling, general and administrative) expenses to CA$144 million also helped lower the EBITDA losses, which came in at CA$68 million, compared to CA$97 million in Q3 2020.
Canopy is safe for now because of Constellation’s investment. However, the continued EBITDA losses could drag down its financial position, so it’s imperative now for the company to achieve positive EBITDA by increasing its revenue. The derivatives products can help with this, given the high demand.
If federal legalization happens in the next few years, Canopy has all the capabilities to march ahead and capture the U.S. cannabis market. A strong balance sheet, steadily growing revenue, reducing operating expenses, and an innovative product portfolio make this pot stock an exciting candidate for your portfolio.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.