Why is downgraded Canopy Growth stock lighting up?

Not even a spate of downgrades has dented Canopy Growth’s [CGC] stock gains this month.

Cowen analyst Vivien Azer sees a 3% revenue decline for the pot grower, moving her rating from Market Perform to Outperform. Azer also chopped her price target in half, going from $26.85 to $12.85. Further piling on the pressure was CIBC downgrading the stock to Underperform, and Canaccord downgrading it to Sell.

Behind the downgrades was a sense that Canopy Growth is taking longer than expected to achieve growth in the US - something that hasn’t been helped by Canopy Growth delaying its goal to achieve positive adjusted earnings. Canaccord analyst Matt Bottomley cited disappointing second quarter results that came ‘well under’ expectations and uncertainty over operations in Canada and global growth.

Despite all this, Canopy Growth’s stock has actually climbed 3.8% since the start of November, going from $12.50 to $14.38 as of Tuesday’s close – although it's worth pointing out that the stock did fall 5.37% in Monday’s session.

Is Canopy Growth stock’s increasingly bearish outlook from the analysts too much of a risk for investors? Or are they about to roll up the gains should an industry-wide turnaround in legislation show signs of progress?

Why legislation could help Canopy Growth’s stock

Cannabis stocks roundly popped at the start of the month after an online magazine broke news that Rep. Nancy Mace is leading a bill to deschedule and tax cannabis. The bill would make cannabis a regulation substance, along with adding a 3.75% excise tax to sales.

Should the bill become legislation it would help the industry finally crack the US. While different states have moved to legalise cannabis, there has been no movement on a Federal level - something that was hoped for following the Democrats’ victory at last year’s presidential elections.

The Motley Fool’s Rich Smith speculates that another reason for Canopy Growth’s strength in the face of downgrades is recent mergers and acquisition activity in the industry.

Rival Curaleaf announced that it was purchasing multi-state operator Tryke Companies. The operator cultivates, processes and runs dispensaries to sell cannabis under the name ‘Reef Dispensaries’. According to Smith, financial services provider Cantor Fitzgerald believes that mergers could be a growth driver for the industry and that the deal for Tryke looks a good move.

“The deal values Tryke at about 7.4 times its EBITDA -- a mere fraction of the acquirer's own valuation -- and explains why Curaleaf shareholders are so happy with the news,” writes Smith.

Where next for investors?

In her analysis, Vivien Azer wrote that "while [the] shares have retrenched, we believe that until the company can demonstrate tangible evidence of a turnaround, there is no meaningful catalyst to warrant appreciation."

“while [the] shares have retrenched, we believe that until the company can demonstrate tangible evidence of a turnaround, there is no meaningful catalyst to warrant appreciation” - Cowen analyst Vivien Azer

Canopy Growth’s most recent quarterly results underlined the difficulty Canada’s pot growers have achieving profitability. In the results, Canopy reported a net loss of C$163m in adjusted EBITDA, well wide of the expected C$50.2m. A big hit was the company writing down C$87m worth of cannabis inventory as demand in Canada, its biggest market, slumped. Behind the write down was consumers shifting to more premium products and tougher competition in lower-priced offerings.

For investors concerned over backing one individual company, such as Canopy Growth, an option could be to spread the risk with an ETF. Cannabis ETFs have reacted favourably to the news, with the Global X Cannabis ETF [POTX] up over 16% and the Cannabis ETF [THCX] up over 10% since the start of November. Even then, it’s advisable to understand the risks involved in a sector that has failed to light up so far this year.