With its second quarter results fast approaching, Canadian cannabis company Cronos Group [CRON] has received a timely boost. On Friday, its shares rose 8.5% off the back of the news it had agreed to acquire part of the Redwood Holding Group, a retailer that sells CBD-infused products including body lotions and edibles.
The acquisition strengthens Cronos’ goal to diversity away from primarily selling plant material, and to build a clear point of difference over its rivals by selling lifestyle products based around what it extracts from cannabis plants.
The deal was made possible by tobacco giant Altria Group [MO], which finalised its purchase of a 45% stake in Cronos back in March for CA$2.4bn. Cronos has been using the investment to widen the number of lifestyle products it sells and the farmers it partners with, hence the Redwood acquisition.
“Like Altria, we believe that the best way to create value to the supply chain is by working with contract farmers and not being farmers ourselves,” Mike Gorenstein, CEO of Cronos, said in an investor call back in May.
Today, Cronos is focusing on research into isolating the various cannabinoids found in a cannabis plant and then using them to try to create a portfolio of recipes that can have therapeutic effects — particularly if this results in liquids that are suitable for vaporizers, which constitute one of the fastest growing areas of the cannabis industry. But what can we expect from the company’s second quarter results on 8 August?
Cronos share price: a look at past performance
In the first quarter, the cannabis producer reported sales of CA$6.5m, up 120% year-on-year. Yet stock fell 10% following the announcement.
One of the reasons Cronos failed to generate excitement among investors is that its CA$6.5m in earnings are still pretty paltry compared to Canadian cannabis market leaders like the Canopy Growth Group [CGC] and Aurora Cannabis [ACB], which each generated a respective $94m and $65m in sales in their last quarterly results.
Q1 year-on-year sales growth
Cronos is also right at the start of its journey in terms of building up a potent cannabis lifestyle brand and a significant, targetable customer base. When it comes to the latter, Cronos only has agreements in place to sell cannabis to adults for recreational use within five Canadian provinces, which represent 58% of the Canadian population, meaning it has access to a much smaller market than its competitors.
“From a revenue perspective, Cronos' recent quarterly sales growth (YoY) was nearly +250%,” according to James Chen, director of trading & investing content at Investopedia, adding that: “Like the other pot stocks on our list, profitability is still significantly negative – return on equity is around -13%.”
Chen says Cronos’ price action shows a good deal of volatility, having been on a rollercoaster ride over the past couple of years. But more positively, he adds: “Since early March, the stock has been correcting pretty sharply, well under its 50-day moving average. It remains in a strong uptrend on a longer-term time frame, and some investors may see this as a potential opportunity to buy the (big) dip.”
“Like the other pot stocks on our list, profitability is still significantly negative – return on equity is around -13%” - James Chen, director of trading & investing content at Investopedia
It’s also worth noting that the Canadian cannabis industry is immature, in the early stages of development, rendering stocks in the sector particularly susceptible to sharp ups and downs. “An investor who invests in Cronos risks attempting to catch a falling knife,” Chen explains, suggesting that investors wait until the stock starts moving upwards before buying.
Cronos stock: buy, sell or hold?
Whether investors choose to back Cronos depends on their faith in the potential for Altria’s investment – a 45% stake in the business in return for $1.8bn – to help take the company to the next level. One thing Cronos certainly has going for it is its cash position. As a result of the Altria deal, Cronos ended the first quarter with cash and cash equivalents of more than $2.4bn — a significant uptick from the $32.6m it had at the end of last year.
|Book Value Per Share (MRQ)||0.93|
Cronos share price vitals, Yahoo finance, 06 August 2019
Cronos now has the potential to invest intelligently and grow quickly, while taking a chunk of the growing CBD market by launching differentiated products. The fact shares of Cronos have risen more than 30% year-to-date as of Friday’s close is a testament to this, and in particular to the power of Altria’s investment.
Most analysts, however, don’t appear to be confident in the stock’s potential, with most recommending it as a “hold”, and two analysts as a “sell”, according to Refinitiv data. The stock does indeed look expensive at present, with a P/E ratio of 50.04, compared to the industry’s 29.73. The stock’s average price target currently sits at CA$15.08, well below its closing price of CA$18.20 on Friday.
While the short-term picture may not be overly hopeful, investors that stick around for the long-term may well be rewarded. Cronos look to be putting some of that spare cash to work, having announced the acquisition of Apotex Fermentation Inc.’s state-of-the-art manufacturing facility in Winnipeg, Canada. The acquisition is expected to close in Q3, with commercial production commencing shortly afterwards.