The immense amount of hype surrounding the cannabis sector in Canada has certainly taken many investors by surprise. Looking at the stock price charts of most producers, one may have to conclude that this was perhaps the greatest investment opportunity of the past half decade, with sentiment remaining extremely bullish among many in the cannabis sector, despite a pullback in recent weeks.
Many investors, noting the double-digit decline in most cannabis producers following legalization in Canada in mid-October, are looking at other, more creative ways of playing this space. In this article, I’m going to discuss why investors ought to consider buying Constellation Brands (NYSE:STZ) (NYSE:STZ) instead of Canopy Growth (TSX:WEED)(NYSE:CGC).
Constellation Brands could control Canopy Growth shortly
As many investors know, Canopy Growth has entered a strategic partnership with Constellation Brands in which Constellation Brands has been given the opportunity to potentially buy enough shares to own a majority stake in Canopy Growth. Currently, Constellation Brands controls just under 40% of Canopy Growth, but with the option to purchase more shares still on the table, the ability of Constellation Brands to buy a majority and controlling stake in the combined entity could impact shareholders in a big way.
The potential could exist down the road for Constellation Brands to make an aggressive offer to take over Canopy Growth, depending on what the cannabis producer’s stock price does in the future. Regardless, at this point in time, it appears the fates of both companies are intertwined in such a way that a purchase of Constellation Brands shares is (almost) a purchase of Canopy Growth shares.
Constellation Brands is trading at a reasonable multiple
Buying shares of Constellation Brands is one way to gain significant exposure to Canopy Growth, while allowing long-term fundamental investors to sleep at night. The trailing 12-month price-to-earnings (P/E) valuation multiple of Constellation Brands is 12 (Canopy Growth’s doesn’t exist since the company has yet to turn a profit). On a price-to-sales basis, Constellation Brands comes in under five (mostly due to its investment in Canopy Growth), with Canopy Growth trading at close to 190 times sales.
The stability of Constellation Brands’s underlying business combined with the opportunity to actually calculate and forecast key financial ratios provides transparency and a pathway for such an equity purchase to be a long-term hold. One of the biggest issues I have right now with the cannabis sector is the lack of transparency about which companies will come out ahead in a consolidation era, which I believe has just gotten started.
Backed by Constellation Brands, I believe buying shares in STZ is a bigger-picture play on consolation in a sector that has just gotten started.
Bottom line
Further consolidation between the “sin” industries of alcohol, tobacco, and cannabis could continue indefinitely, and betting on the large players such as Constellation Brands to continue to consolidate this space may be prudent for long-term growth investors.
Being a cautious fundamental value investor, I remain on the sidelines with this trade, but would encourage investors hellbent on buying Canopy Growth stock to consider other options to gain exposure, considering the company’s balance sheet risk at this point in time.
Stay Foolish, my friends.
Fool contributor Chris MacDonald has no position in any stocks mentioned in this article.