Canopy Growth will remain a problem for Constellation Brands, this investor says

The write-downs likely aren’t done yet. That’s the takeaway from portfolio manager Jason Mann’s assessment of Constellation Brands (Constellation Brands Stock Quote, Chart, News NYSE:STZ) and its troubled investment in cannabis company Canopy Growth (Canopy Growth Stock Quote, Chart, News TSX:WEED). And while Constellation showed good results in its latest quarter despite the negative impact of Canopy, Mann is staying bearish on the name.

Constellation made a big splash in August 2018 with a US$4-billion investment in Smiths Falls, Ontario’s Canopy Growth, a leader in the cannabis space with designs on international dominance as jurisdictions worldwide continue opening up to legal marijuana.

The new arrangement had Constellation upping its stake in Canopy from ten to 38 per cent and gain further representation on the latter’s board of directors. At the time, Constellation’s purchase was seen as a key stamp of confidence for the burgeoning pot industry, one which was followed up by a run on cannabis stocks in the lead up to Canada’s adult-use legalization in October of that year.

At the time of the Canopy deal, Constellation Brands executive chair Rob Sands said, “Over the past year, we’ve come to better understand the cannabis market, the tremendous growth opportunity it presents, and Canopy’s market-leading capabilities in this space. We look forward to supporting Canopy as they extend their recognized global leadership position in the medical and recreational cannabis space.”

But the relationship showed signs of stress the following year, with Constellation reportedly growing more impatient with Canopy’s ballooning losses and lack of clear path to profit. The first shoe to fall was the dismissal of Canopy co-CEO and face of the cannabis industry Bruce Linton in June of last year, with his replacement coming in December in the form of Constellation CFO David Klein.

And while Constellation’s moves to right the ship have been applauded on many fronts, it has nonetheless felt the sting of its multi-billion gamble on cannabis. Earlier this month, the company released its fiscal third quarter 2020 numbers which beat analysts’ estimates for profit even as Constellation recognized a US$534-million drop in fair value for its Canopy investment.

That’s not a good sign, said Mann, chief investment officer at EdgeHill Partners, who spoke to BNN Bloomberg on Friday, saying that Constellation Brands is also a pricey stock on a comparative basis.

“I have a feeling that they’re probably going to be more write-downs related to [Canopy],” Mann said. “Right now, it’s a small short for us. Like a lot of these staple stocks — this is technically discretionary — but it’s in that expensive staple bucket at 19x EBITDA and 22x P/E, so the valuation is not that compelling, particularly when you know that they’re potentially going to have some write-downs on that [Canopy] purchase.”

“And price momentum has gone sideways, partly because of the expensive purchase of Canopy at the top. So, small short for us, not overly compelling but certainly not a long,” he said.

2019 was a rough year for cannabis all around, as companies dealt with a slower-than-expected expansion of the market in Canada and a drying-up of available capital across the industry. But Constellation Brands is staying optimistic on its investment.

“We remain bullish on the Canadian cannabis market as the conversion of the illicit market to the legal market continues to strengthen,” said Constellation CEO Bill Newlands in the January conference call.