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Constellation Brands Makes a Big Bet on Cannabis

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Alcoholic beverage giant Constellation Brands (STZ - Free Report) announced Wednesday that it would invest almost $4 billion to acquire a 38% stake in Canadian cannabis company Canopy Growth Corporation. Constellation already owned roughly 10% of Canopy and will pay a 51% premium to the current market price on 105 million shares while also acquiring warrants that, if exercised, would give Constellation ownership of more than 50% of Canopy. The exercise price on the warrants is an additional $4.5 billion.

Constellation will also assume four out of the seven seats on the Canopy board of directors.

Constellation is a global collection of brands producing well known beers, wine and spirits, such as Corona, Robert Mondavi and Casa Noble Tequila. Their stated goal in the transaction is to “position Canopy Growth as the global leader in cannabis production, branding, intellectual property and retailing.”

Is it Legal?

Canada voted earlier this year to legalize the recreational use of cannabis and plans to have a framework in place by September to regulate the cultivation, distribution and retail sale of cannabis products.

In the United States, cannabis is still illegal at the federal level where it is classified as a Schedule 1 narcotic with no recognized medicinal uses. Rules across individual states vary widely with 30 states having legalized medical marijuana and 9 states and the District of Columbia also allowing recreational use and sale.

The previous administration had made clear its intention to allow states to make their own rules regarding legalization, but the Trump administration and especially Attorney General Jeff Sessions have vowed to take a tougher stance. The disparity in laws has impeded the creation of large-scale cannabis businesses in the U.S. as operators generally do not have access to traditional banking services and pay taxes at different rates that, in some cases, do not allow them to deduct operating expenses from gross revenues for the purposes of taxation.

Because of these challenges, there are no pure-play Marijuana companies listed on U.S. exchanges other than microcap Cronos Group - which is essentially a holding company - though there are several companies that have significant exposure in ancillary goods and services. Zacks strategist Tracey Ryniec covered some of these companies in her Market Edge Podcast last week.

Constellation’s Plan

In an interview with CNBC, Constellation CEO Rob Sands estimated that the Cannabis industry would have over $200 billion in global sales by the year 2030 – up from $10-20 billion in legal sales currently. Constellation anticipates that as a “first mover” in the space they will be able to capture a significant portion of that $200B.

Sands also clarified that Constellation’s strategy is to operate the Cannabis operation as a fourth division of the company and that they had no plans to combine Cannabis with alcohol, but did not rule out the possibility of Cannabis beverages as one of many product offerings.

For reference, in 2017 Constellation sold $4.2B in beer, $2.7B in wine and $361M in spirits, so the company would only have to have about a 3% share of that anticipated $200B market for Cannabis to become its largest division.

Is this the Best Way to Invest in Cannabis?

In what was already a down day for the major averages, investors punished Constellation shares on the news, selling the stock down 6% or over $13. That loss represents $2.5 billion in market capitalization or about two thirds of the value of the announced deal. Thanks to an earnings miss in the fiscal first quarter and 6 downward analyst revisions, Constellation Brands is a Zacks Rank #4 (Sell).

Future downward revisions are not out of the question as Constellation is paying a hefty premium for Canopy Growth to create a division that may not be accretive to earnings for a considerable amount of time.

Although investors may hope to get in on the ground floor of the Cannabis industry as public opinion and the laws that govern it change both in the U.S. and abroad, Constellation has a long way to go before it makes big money on it. When and if the legal situation in the U.S with regard to legalization and regulation become more clear, there will almost certainly be pure-play Cannabis business that investors can choose with confidence, but for the time being, buying Constellation to get exposure to the Cannabis market is a speculative bet at best.

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