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The Most Hated Pot Stock Logs Another Sell Rating

The Most Hated Pot Stock Logs Another Sell Rating

The marijuana industry is transforming before our eyes, and Wall Street is taking notice. Over the past couple of months, quite a few Wall Street investment banks have chimed in on the long-term sales outlook for the industry, as well as initiated coverage on a handful of marijuana stocks.

For example, the cannabis industry's biggest cheerleader, Cowen Group, is looking for $75 billion in global sales by 2030, up from $12.2 billion in 2018, and has named Aurora Cannabis (NYSE: ACB) as its top pick in the industry. Covering analyst Vivien Azer notes that Aurora has industry-leading peak production potential, and has done a particularly good job of moving into overseas markets. Recently, Aurora announced that it has a distribution and/or production presence in 24 countries worldwide, which should come in handy if and when dried cannabis flower becomes oversupplied and commoditized in Canada.

Dice that say buy or sell being rolled atop a digital screen containing stock quotes.
Dice that say buy or sell being rolled atop a digital screen containing stock quotes.

Image source: Getty Images.

Meanwhile, in late February, Jefferies analyst Owen Bennet initiated coverage on nine pot stocks, labeling five of them as a buy. Although no particular marijuana stock was singled out as Jefferies top choice, The Green Organic Dutchman (NASDAQOTH: TGODF) was given the most aggressive price target, based on its share price at the time the coverage was announced. The Green Organic Dutchman had 195,000 kilos of peak capacity at the time of coverage, but has since upped its forecast to 219,000 kilos as a result of technological improvements with its constructed greenhouses. Without a brand-name partner, The Green Organic Dutchman may also have another catalyst on the horizon.

Last week, another investment bank joined its peers by initiating coverage on four pot stocks. Bank of America is rating the two largest pot stocks in the world by market cap, Canopy Growth and Aurora Cannabis, as buys, along with HEXO, which became B of A's top pick.

Another day, another sell rating for this hated marijuana stock

Of course, one of the four companies Bank of America initiated coverage on wasn't so lucky: Cronos Group (NASDAQ: CRON). Then again, receiving the equivalent of a sell rating has sort of become the norm for the third-largest pot stock by market cap.

B of A initiated coverage on Cronos with an underperform rating and a price target of 17 Canadian dollars ($12.73 U.S.), representing downside of exactly 20% from where Cronos Group's share closed on Wednesday, April 17. Though Bank of America likes the company's cash-rich balance sheet, covering analyst Christopher Carey is concerned about the company's premium valuation and skyrocketing share price since the year began.

An investor in a suit pressing the sell button on a digital screen.
An investor in a suit pressing the sell button on a digital screen.

Image source: Getty Images.

And make no mistake about it, Bank of America isn't alone. Both Jefferies and BMO Capital Markets have initiated sell ratings on Cronos Group's stock, with Canaccord Genuity lowering its rating on the company from hold to sell following its abysmal fourth-quarter operating results in late March.

Furthermore, GMP Securities downgraded Cronos from buy to hold in early February, while Cowen Group, again, the biggest cheerleader, initiated Cronos at market perform while maintaining pretty much every other pot stock it follows as a buy. It is, unquestionably, the stock market's most hated pot stock.

But why, you ask? Let me count the ways.

Here's why Cronos Group is worth avoiding

The primary reason Cronos Group shares have rallied so strong over the past four-plus months is the $1.8 billion equity investment the company received from tobacco giant Altria, which was good for a 45% nondiluted stake in the company. Combined with the warrants it also received, Altria could take a majority position in Cronos, or simply acquire the company, at a future date. Although this cash is a positive, it's about the only reason to even consider Cronos Group as an investment.

The first issue is that Cronos Group's production capacity is laughable, relative to its size. Despite having a market cap of more than $5 billion, Cronos Group may struggle to hold on to its position as a top-10 producer of cannabis. Currently, the company's 850,000-square-foot joint venture that's capable of 70,000 kilos at its peak, Peace Naturals (40,000 kilos), and a handful of overseas production facilities might get the company to 120,000 kilos by 2021. Meanwhile, Aurora Cannabis is already producing at an annual run-rate of more than 150,000 kilos, and CannTrust Holdings, which might double Cronos Group's peak annual output, has a market cap that's less than a sixth that of Cronos.

Potted cannabis plants growing under special indoor lighting.
Potted cannabis plants growing under special indoor lighting.

Image source: Getty Images.

To add to this point, Cronos Group's production is coming to market considerably later than its large peers. Its joint venture buildout isn't yet complete, and the company generated a pitiful $4.2 million in revenue during the fourth quarter, despite Canada having legalized recreational weed.

This is also a company that hasn't done a particularly good job of pushing into overseas markets. Whereas Aurora Cannabis has distribution or production activity ongoing in 24 markets, Cronos has modest output potential in Israel and Australia, and distribution agreements in Germany and Poland. That's it. If and when domestic Canadian dried flower production overwhelms the market, Cronos Group is going to find itself between a rock and a hard place if it can't create external sales channels to sell its dried flower.

Add this up, and we have a pot stock that has a very real chance of losing money in 2019 as it plays catch-up, and might lose money again in 2020 as it looks to build up and market its brands, as well as expand into overseas markets. Yes, Cronos Group is flush with cash, but cash provides only a certain amount of buffer.

At this point, just about any pot stock looks to be a better investment than Cronos Group, and Wall Street knows it.

More From The Motley Fool

Sean Williams owns shares of Bank of America. The Motley Fool recommends CannTrust Holdings Inc and HEXO. The Motley Fool has a disclosure policy.

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