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Canopy Growth Has Hit a Dead End

The sector-wide fall is not a buy-low opportunity.

Pixabay, Rex Medlen

It was supposed to be a routine police raid…

But when the cops stormed an illegal cannabis operation in California earlier this year, even grizzled veterans were shocked by what they found.

They went in expecting to confiscate marijuana plants from a farm. Instead, they found a factory cranking out 500 pounds of cannabis a day. That’s nearly enough to supply all legal dispensaries in California!

As you may know, California legalized recreational cannabis in 2018… an act that was supposed to put an end to the illegal black market. Instead, the total opposite has happened. Black market cannabis is thriving.

Two years after legalization, 80% of the cannabis sold in California still comes from the black market. And get this… legal spending has DROPPED 17% since California legalized cannabis, according to Arcview.

This development is a huge, overlooked threat to cannabis stocks. If you own any, especially Canopy Growth, here’s what you need to know…

Have You Seen Canadian Cannabis Stocks Lately?

It’s a bloodbath.

Here’s Canopy Growth [WEED:CA, CGC]… down 65%.

Aurora Cannabis [ACB:CA, ACB]… crashing 74%.

And Cronos Group [CRON:CA, CRON]… slipping 71%.

If you’ve been following my work on cannabis stocks, you saw this coming from miles away back in August. But make no mistake, these stocks aren’t merely “taking a breather.” They’re crashing. And I don’t see them going anywhere but down for at least the next six months, for one simple reason.

The Canadian Black Market

Cannabis was legalized in Canada last year. But 2018 was not the first time most Canadians had tasted it. Millions of kilos of cannabis had been smoked in Canada way before the legalization. It’s been a multi-billion dollar industry for a hundred years.

The only difference is that it was conducted on the black market, illegally.

Just like in California, legalizing cannabis was supposed to kill the black market in Canada. Just like in California, the opposite is happening.

A year after Canada’s historic legislation, the Canadian cannabis black market isn’t just alive—it’s booming! Today, 4 in 10 Canadians buy at least some of their cannabis from illegal sources, according to StatsCan. And in 2019, the black market is expected to make up 71% of all cannabis sales in 2019.

The Biggest Cannabis Lie

Mark Zekulin, CEO of Canopy Growth, appeared on TV the other day. He commented on the company’s record-high losses for returned products and excess inventory. The company lost $1.6 billion in the past six months… 3X more than last year.

As you may know, Canopy Growth is the world’s largest cannabis producer…and one of investors’ favorite stocks in the sector. Here’s what Mark said:

“There are not enough stores in Canada to sell our products… and it’s very hard to take on the black market”

In other words, he said that the lack of legal dispensaries is Canada is at the root of Canopy Growth’s struggles. Once more legal stores open up, black market competition will vanish. That’s a big, capital-L lie.

If California is any indication, access to legal cannabis won’t disrupt the black market. Quite the opposite… it will make it thrive.

It All Comes Down to Price

“One customer told me, ‘I love you and I want to support you, but I can’t buy all my cannabis here. It’s too expensive,’ ” said Jeremy Jacob, co-owner of a Vancouver cannabis store. That’s one of the many stories you hear from owners of the first Canadian pot stores. It reflects the main problem with the legal pot industry.

Legal cannabis is expensive!

In Canada, you can buy a gram of cannabis on the street for C$5.59. In a legal store, you must shell out over C$10.23 for the same amount, according to Statistics Canada.

You see, the government of Canada levies huge taxes on legal cannabis… which inflates its price to practically double that found on the black market. This makes it impossible for a legal producer like Canopy Growth to compete with street dealers.

Canopy Growth Is Sitting on Mountains of Inventory

Let me show you the most important chart about Canopy Growth. It shows how it’s piling up bigger and bigger inventories of cannabis…

It took just a year for the company to fill up its warehouses to the brim with hundreds of thousands of kilos of the product. But because of the black market, only a fraction of it has been sold.

While Canopy Growth is falling over itself to produce more and more flower, most folks are still buying what they desire from street dealers.

The Math Doesn’t Add Up

I ran the numbers. Canopy Growth has to sell over C$3 billion worth of additional cannabis a year to get its head above water. That’s 300,000 to 600,000 kilos per year.

This is more than half of what the entire Canadian market consumes in an entire year, according to Statistics Canada. Since the black market makes up 71% of the Canadian cannabis market, most of Canopy Growth’s product will stay in warehouses to rot.

Meanwhile, the company’s losses are mounting by the day. This can’t go on forever.

My recommendation: don’t buy the dip in Canopy Growth or other stocks in the sector. As tempting as a 60% discount sounds, Canopy Growth is a money-burning machine that has hit a dead end.

I see much more blood on the streets from here.

Written with the assistance of Dainius Runkevi?ius.


Equities Contributor: Stephen McBride

Source: Equities News