Shares in Canadian cannabis company Cronos [CRON] plummeted as much as 9% to US$14.06 on Thursday in the wake of Q1 results that fell short of analysts’ estimates.
Revenues totalled C$6.5m in the quarter, up 120% year-on-year thanks to the legalisation of cannabis products in Canada, but short of the C$7m expected by analysts. Adjusted EBITDA came in at a negative C$9m, a six-fold increase in losses compared to Q1 2018.Cronos Group 1-year share price performance, CMC Markets, 15 May 2019
CEO Mike Gorenstein guided for earnings to further decline throughout 2019, but said investments in ancillary cannabis products would “position the company for accelerated growth in 2020”.
Capital injection smooths out production kinks
Gorenstein also announced the completion of a C$2.4bn (US$1.8bn) investment in Cronos by tobacco conglomerate Altria Group [MO]. The transaction gives a logistical and R&D boost to Cronos, Gorenstein said, as it looks to tap into what it sees as a burgeoning market for products other than pure marijuana.
“Altria … has significant expertise that can serve as a foundation for cannabis-based products as well as considerable experience with large scale manufacturing automation, pre-roll technology, and supply chain management,” Gorenstein said.
|Quarterly Revenue Growth (YoY)||119.70%|
Cronos Group share price vitals, Yahoo finance, 15 May 2019
Edible products and vaporizers have been highlighted by the company as one of the avenues for growth, with initial efforts focused around the latter category. “I think that the regulations around vaporizers are … much more likely to stay the way that they are today,” Gorenstein said. “Edibles, for us it’s really about understanding what those final regulations are and how we launch products, and specifically in what categories.”
As Gorenstein adopts a wait-and-see approach to the growing uncertainty surrounding the tightening of regulations for edibles, the company could see a boost with the help of its Marlboro-maker investment in the meantime. Altria’s product experience in automation will be an asset when it comes to the packaging of vape pens and pre-rolled joints, which has been a sore point for the wider sector.
Indeed, pot producers such as Aurora Cannabis [ACB] and Canopy Growth [CGC] failed to anticipate the pervasive supply chain issues, as many reportedly struggle to manually apply the required excise tax stamps on products. Cronos’ strategic investment should make the company successful in automating production, just as Canada’s OrganiGram [OGI] has recently proven.
Cronos is also looking to take advantage of the relatively more relaxed import and export regulations around cannabis-infused products compared to recreational marijuana, Gorenstein added. “We see borders falling much faster for non-intoxicating products primarily that are CBD-based,” he said, referring to the compound cannabidiol, or CBD, that’s found in cannabis plants.
While cannabis sales at Cronos have been constrained by supply, derivatives should pose an opportunity to tap into a wider network of suppliers. Gorenstein said that Cronos has been wary of ramping up third-party purchasing and contract growing of marijuana due to the difficulties of getting to a final, standardised product, but this would be less of a concern with derivatives. “For vapes, there is a lot we can do to bring in biomass or third-party extracted products and then reinject, recombine different Terpenes and cannabinoid mixtures to have something that’s actually standardized,” he said.
While analysts were underwhelmed by the earnings results – “Cronos is testing investor patience,” wrote GMP Securities’ analyst Martin Landry – the pivot to derivatives, combined with a fresh cash injection from Altria’s investment has been well-received.
“We believe Cronos is setting up for a strong launch of concentrates – more specifically vape pens. Altria has significant expertise in the vaping industry through its investment in JUUL and we expect this will translate into success in the Canadian rec market when vape pens are allowed,” wrote PI Financial’s Jason Zandberg, who expects the legalisation of vape pens in the country to happen as soon as October.
Over at BMO Capital Markets, Tammy Chen was also bullish on the Altria partnership. “We expect there have been significant R&D conducted by Altria on vape technologies that could be transferable to cannabis,” she wrote.
“We expect there have been significant R&D conducted by Altria on vape technologies that could be transferable to cannabis” - BMO Capital Markets Analyst, Tammy Chen
“We believe the partnership with Altria provides Cronos with capital for intellectual property and product development, and Cronos should benefit from Altria’s global distribution and branding strategies. Cronos, with Altria’s expertise, could be a leader in the vape pen category at the onset of cannabis 2.0 products.” Zandberg and Chen lowered their price targets to C$22 and C$17 respectively.