U.S. Markets closed

This Pot Stock Has Turned Into Wall Street's Pinata

Sean Williams, The Motley Fool

The marijuana industry is quickly becoming a big-money business. Despite it generating just a few billion dollars in legal sales a few years ago, Wall Street investment banks are now calling for worldwide cannabis sales to hit between $50 billion and $75 billion by the end of the next decade.

This exceptional sales growth potential, coupled with the prospect of ongoing legalization opportunities throughout North America, is a big reason behind the long-running rally in pot stocks. Many of the largest brand-name marijuana stocks have risen by a quadruple-digit percentage since the beginning of 2016, with no brand-name pot stock outperforming Cronos Group (NASDAQ: CRON), which is up close to 7,000%.

An up-close view of a flowering cannabis plant growing in a hybrid greenhouse.

Image source: Getty Images.

Cronos Group becomes Wall Street's punching bag

Unfortunately, we as investors know that not every company can be a winner in a fast-growing industry. Even companies that look like early leaders don't always wind up as the best investments. Whereas most marijuana stocks have been generating optimism and, at worst, the equivalent of a hold rating from Wall Street, Cronos Group has earned its reputation as the most hated pot stock of all.

Heading into May, Cronos Group was the only marijuana stock with four sell ratings from Wall Street analysts. BMO Capital, Jefferies, and Bank of America all initiated Cronos Group at the equivalent of a sell rating, with GMP Securities lowering its rating on the company from hold to sell in late March. Even Cowen Group, which is arguably the biggest cannabis cheerleader on Wall Street, has only been able to muster the equivalent of a hold rating on Cronos Group.

But here's a news flash: Things can actually get worse. Although Wall Street can't exactly punish Cronos much more from a rating standpoint, it certainly can adjust its price targets lower on the company's stock. Since May began, a number of Wall Street firms have turned Cronos Group into their own personal pinata by cutting their price target on the company. Here are those cuts, listed in Canadian dollars (CA$), and in no particular order:

  • Cowen Group slashed its price target to CA$21 from CA$26
  • Canaccord Genuity adjusted its price to CA$16 from CA$17
  • PI Financial cut its price target to CA$22 from CA$24
  • Jefferies lowered its price target to CA$15 from CA$17
  • GMP Securities reduced its price target to CA$21 from CA$23
  • BMO Capital decreased its price target to CA$17 from CA$19
  • CIBC dropped its price target to CA$25 from CA$30

Again, all of these price-target adjustments were completed in a span of just 10 days, proving without a shadow of a doubt that Cronos is Wall Street's most hated pot stock.

A businessman in a suit giving the thumbs-down sign.

Image source: Getty Images.

Here's why Wall Street (rightly) hates Cronos Group

If there's one thing Cronos has working in its favor, it's the company's potentially game-changing equity investment from Altria. The producer of Marlboro tobacco cigarettes invested $1.8 billion in Cronos in March to net itself a 45% non-diluted equity stake. In return, it gains access to the fast-growing cannabis industry, and it may be able to work with Cronos to develop pre-roll and vape products throughout North America.

As for Cronos, it winds up with a much-needed cash pile of $1.8 billion that it can use to make complementary acquisitions, expand production capacity, broaden its product portfolio, and push into international markets. This cash balance -- the second largest of any pure-play pot stock -- is a big reason why Cronos Group has grown into the third-largest pot stock by market cap.

So, why doesn't Wall Street like this cash-rich company? Namely, because it hasn't demonstrated that it can keep up with its similarly sized peers.

In terms of production, Cronos Group aims to deliver 117,500 kilos a year at its peak, according to company estimates. This includes 70,000 kilos from a 50-50 joint venture with a group of investors, meaning it'll only be privy to half of the revenue it generates from the facility that comprises 60% of its aggregate output. Comparatively, there are eight growers projected to generate more cannabis each year than Cronos, with the Pure Sunfarms joint venture and Auxly Cannabis Group expected to sell more marijuana each year, when operating at peak capacity. In other words, Cronos Group isn't even really a top 10 pot stock, despite being valued as a top three player.

A person holding cannabis leaves in front of a globe of the Earth.

Image source: Getty Images.

Cronos Group also has a pretty poor international presence, relative to its size. Aurora Cannabis had access to 24 countries when the month of May began, with Canopy Growth, Tilray, and Aphria all right around one dozen countries. As for Cronos, it has distribution agreements in place in Germany and Poland, and modestly sized grow sites in Australia and Israel. That's it! If Cronos Group doesn't significantly expand overseas, or focus primarily on cannabis derivatives, its operating margins could get throttled by dried-flower oversupply.

With the exception of its cash, Cronos Group's income statement has also been laughable. In the five-and-a-half-month span between Oct. 17, 2018, and March 31, 2019, when recreational weed was legal in Canada, the company managed just $10 million (U.S.) in sales, which is well off the pace of its peers. Similarly, remove a number of one-time benefits and fair-value adjustments and it's readily apparent that Cronos Group is losing money hand over fist on an operating basis.

Outside of its cash hoard, Cronos isn't offering a very compelling investment story, and the barrage of sell ratings and recent price-target cuts it's received is evidence to this fact.

More From The Motley Fool

Sean Williams owns shares of Bank of America. The Motley Fool recommends Auxly Cannabis Group. The Motley Fool has a disclosure policy.