Why Investors Must Approach the Spike in Canopy Growth (CGC) Carefully

While the major equity indices suffered a soft day for the Aug. 2 session, one company stood out for its remarkable ascendency. Following the ringing of the closing bell, shares of Canopy Growth (CGC) found themselves up over 13% from the prior day. As well, the post-market session saw CGC stock slightly extend its gain, rising a hair over 1%.

What startled casual market observers is the sharp contrast between nearer-term bullishness and longer-term pessimism. Even with Tuesday’s double-digit leap, CGC stock has hemorrhaged over 69% of market value on a year-to-date basis. Arguably, most investors will likely concentrate on the red ink versus the single-day splash of green ink, robust as it was.

Adding to the perplexing move, it occurred on little apparent news. Therefore, analysts reasoned that two factors were at play. First, Switzerland recently legalized medical cannabis for patients with a doctor’s prescription, thus implying that the total addressable market for the historically maligned plant will eventually expand. Second, this dynamic may have inspired Wall Street to take a closer look at fiscal year 2022 results for sector rival Tilray (TLRY).

Like CGC stock, Tilray jumped substantially higher on the Aug. 2 session, gaining 14% on the day. Though its financial performance wasn’t comprehensively encouraging, management did emphasize that net revenue increased 22% to $628 million. With enough time, the cannabis industry could theoretically mount a comeback.

However, investors need to exercise much caution before engaging Canopy Growth or any cannabis player for that matter.

Inflation Woes Might Impede CGC Stock

While Tilray had other positive details to bring to light – including expectations to be free cash flow positive in its operating business units in FY 2023 – it was the net loss of $457.8 million in its fiscal fourth quarter (ended May 31, 2022) that caught critics’ attention.

For one thing, in Q4 of FY 2021, Tilray delivered net income of $33.6 million, thereby creating an extremely sharp contrast. Another factor to consider is why the company printed red ink in the first place. According to management, several headwinds, notably “market conditions inclusive of higher rates of borrowing” contributed to the quarterly net loss.

Reading between the lines, the Federal Reserve’s commitment to addressing the inflation dilemma by raising the key benchmark interest rate appears to be negatively affecting cannabis operators, which doesn’t augur well for CGC stock. The more consumer prices rise, the less likely people will acquire products and services unless they are absolutely necessary.

For CGC stock and its ilk, the main economic and monetary headwind is that rising energy costs represent the bulk of the inflation rate. However, households have little choice but to pay these exorbitant prices, leaving fewer funds available for other purchases.

On paper, this dynamic should pressure the cannabis industry. However, the legal channel is not the only way to obtain the material.

The Black Market is the Pink Elephant in the Room

Part of the allure of cannabis stocks is the underlying transition of an illicit (and therefore untaxable) market to a legitimate endeavor, one that could help bolster governmental revenue channels. That was the theory, anyways. In reality, the situation has played out differently than expected.

In May of this year, I wrote that the state of Oregon was facing a legal cannabis conundrum. “Supporters of the go-green movement argued that legalization would mitigate if not eliminate the black market. Instead, the black market is thriving. And present economic conditions make it unlikely that illicitly manufactured cannabis will shrivel against its legally sourced counterparts.”

Of course, the pivotal negative catalyst inherent in the black market is that its operators don’t pay any fees or taxes. Therefore, the illicit cannabis players can undercut their legally operating counterparts, effectively negating all the work that went into legitimizing the still-maligned industry.

To be clear, consumers who engage the cannabis black market are asking for serious legal troubles, along with professional and reputational losses. However, with law enforcement agencies struggling to manage serious crimes, many jurisdictions might not want to deal with the high-effort, low-benefit profile of pursuing mundane cannabis-related violations.

A Risky Trade Only for the Speculators

Despite the myriad points of apprehension regarding CGC stock, anything can happen in the equities market. Therefore, it’s not impossible for Canopy Growth to build on its recent momentum.

However, rival Tilray’s financial statements suggest that broader economic factors such as rising inflation and subsequent higher interest rates are negatively affecting the cannabis industry. Combined with the allure of the black market – and law enforcement’s general reluctance to pursue such low-level crimes – investors must be very careful about engaging CGC stock.

• U.S. Stocks Lower on Taiwan and Sharp T-note Yield Rise
• Hertz Is Doubling Down on Stock Buybacks
• Are Bearish Times for US Stock Markets Over?
• S&P 500 seasonals turn negative for August-September