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Cronos (CRON) Stock May Have Further to Fall After Earnings

In the course of a year, Cronos Group (CRON) has gone from a beloved cannabis stock to one hardly discussed. Ironically, the stock still maintains one of the richest valuations in the cannabis sector trading above $14. Absent a big Q2 that isn’t in the cards, Cronos has substantial downside risk ahead.

Massive Market Cap

Despite about a 50% decline from the highs, Cronos has a market valuation in the $4.6 billion range. The Altria Group (MO) investment has bolstered the balance sheet with $2.4 billion in cash, but a few more cash deals will quickly wipe out the cash hoard.

The company only generated Q1 net revenues of $6.5 million, yet the stock has a valuation around the richest multi-state operators (MSOs) in the U.S. with revenues forecast at 10x the level. In essence, Cronos is a relatively minor player in the sector outside of the Altria deal having only sold 1,111 kilograms in the last quarter.

Even more concerning, analysts don’t forecast Cronos Group ramping up revenues significantly anytime soon. Q2 revenues are forecast flat sequentially and targets don’t have the Canadian cannabis company crossing $200 million in annual sales until 2020.

Those types of sales levels don’t correspond very well with a market cap anywhere above $2 billion, if not down at $1 billion. As the cash balance disappears so will the stock valuation.

5-star Canaccord analyst Matt Bottomley recently noted: "CRON currently trades at ~58x our 2020E EV/EBITDA, which is a significant premium to even the leading large-cap players in the space at ~40.0x with significantly higher recreational market shares and greater near-term revenue visibility vs. Cronos. As a result, we are maintaining our SELL rating at this time." (To watch Bottomley's track record, click here)

Cash Deal

On Friday, Cronos announced a deal to purchase Redwood Holding Group, LLC for ~$300 million. Redwood owns the Lord Jones CBD brand focused on hemp-infused skincare and consumer products.

The transaction is for $225 million in cash and 5.1 million shares at $14.7446 per share. As with most cannabis deals, the financial details of the acquired company are missing from the discussion.

For Cronos Group to maintain a market valuation in the $5 billion range, the company needs to start providing the financial details to back a $300 million deal for a company partially owned by the CEO and a Director of Cronos Group.

The real questionable part of the deal is that Reedwood is mostly cashing out of the CBD market with 75% of the deal in cash. For a company partially owned by insiders, Redwood sure doesn’t want shares in Cronos. The founders of Redwood are expected to stay around and lead the development of the LJ brand, but one has to wonder how long the employment last as the 5.1 million shares are a fraction of the deal and the share lock up lasts only 1 to 2 years.

Takeaway

The key investor takeaway is that Cronos Group remains a highly valued cannabis stock with very little substance. The recent deal, mostly in cash, questions whether industry insiders don’t see an issue with the stock valuation as well.

At the least, Cronos remains dead money until the company aggressively uses the cash to expand the revenue base. At the worst, the stock continues the down trend due to a lack of actual business to match the market cap.

Disclosure: No position.