Cannabis stocks are starting to lose their shine. Ever since Altria Group (NYSE: MO) took a $1.8 billion stake in Cronos Group (NASDAQ: CRON) in December 2018, Cronos, and stocks in this sector are trending lower. With reality setting in following an uninspiring quarterly earnings report, what will it take for Cronos stock to stop falling?
Altria’s $1.8 billion investment in Cronos is frighteningly big relative to the current revenue generation. In the first quarter, Cronos reported revenue of just CAD $6.5 million (USD $4.8 million). Q1 GAAP earnings-per-share came in at CAD 48 cents (USD 36 cents). Still, Altria’s large investment is a bet on the future potential revenue from Cronos.
The tobacco giant is bringing its decades of experience in navigating through a complex regulatory landscape. As it handles government regulatory affairs, licensing and other legal issues, Cronos will need Altria’s expertise in marketing and developing a scalable cannabis supply chain.
First Quarter Highlights
Cronos reported an EBITDA loss of $8.9 million, with losses up 13% sequentially from Q4 2018. Higher expenses were partially offset by the higher net revenue of $6.5 million. Revenue increased due to dry flower wholesale revenue, which faced no excise tax reduction for the year. Supply constraints limited the revenue growth but the company expects additional production capacity arriving in the second half of this year.
Looking ahead, the adjusted EBITDA will still decline throughout 2019. Cronos plans on increasing R&D spend; this will lead to accelerated growth in 2020.
Favorable Product Mix
ASP (average selling price) rose 7% to $5.73 sequentially, due primarily to higher revenue from CBD oil. This product does not carry an excise tax reduction, lifting revenue. The 42% increase in gross profit, to $3.5 million, is due to the cost of sales falling 11% sequentially to $2.69.
Building Supply Channel
In the first quarter, Cronos secured listings with private retailers in Saskatchewan. This adds to its established distribution in Ontario, British Columbia, Nova Scotia and Prince Edward Island. Together, the five provinces account for 58% of the Canadian population.
Thanks to the additional liquidity provided from Altria’s investment in the company, Cronos continued scaling its business. It plans on increasing its capital investments to the production related to the Peace Naturals facility expansion. It also plans to invest in automation equipment at GrowCo and at the Israel facilities.
Investors have high expectations for Cronos ramping up output. Its output was around 1,000 kilos in the first quarter but it aims for 40,000 kilos next. In its next quarterly earnings report, investors will look for evidence that the supply chain and distribution model supports the higher output.
Cronos is prioritizing hemp over marijuana, which should lower the regulatory risks investors face in holding the stock. CBD regulations may still limit the market size in the near term in places like Germany or in the E.U. Still, expanding the output of CBD-based products take priority over THC because the market for the former will expand more rapidly.
Cronos is bullish on its partnership with Ginkgo Bioworks. From the balance sheet, investors will notice the R&D spend, in which some of it is related to its payments to Ginkgo. Cronos reached its milestones with Ginkgo and the latter continues to make progress in the area of synthetic biology.
Valuation and Your Takeaway
After Cronos reported first-quarter results, only one of the nine analysts covering the company updated their rating to a “hold.” Per Tipranks, the average price target on CRON stock is $21.50, which implies an upside of over 42%. Cronos stock traded recently at $15.15.
From a charting perspective, CRON stock looks like it peaked at between $22 – $24 in February. Selling pressure continues to pull the stock lower. But with billions in cash on its balance sheet, Cronos has plenty of resources to build its business. If it gets ahead of its competitors in getting its supply chain at full capacity, it will grow market share quickly. For that reason, the long-term prospects for Cronos appear bright.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.
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