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Why Much-Maligned Cronos Group Could Be a Sleeping Giant

Keith Speights, The Motley Fool

After soaring more than 120% by early March, Cronos Group (NASDAQ: CRON) quickly became the subject of scorn. My Motley Fool colleague Sean Williams called Cronos "the most overvalued pot stock" soon thereafter. He followed up by referring to Cronos as "the most hated pot stock." And there was a reason to think that Cronos deserved that label, with analysts downgrading the stock and Cronos shares sinking at one point more than 40% below its highs.

Even some analysts who generally like Cronos Group think that the stock's valuation got out of hand. Stifel analyst Andrew Carter recently wrote to investors that there's "some downside potential" for Cronos because of its steep valuation.

But not everyone is down on Cronos Group. Last week, Bank of America Merrill Lynch analyst Christopher Carey upgraded Cronos from a sell to a buy. Here's why this much-maligned marijuana stock just might be a sleeping giant.

Cannabis leaf on top of a $100 bill.

Image source: Getty Images.

Coming to America

Cronos Group CEO Mike Gorenstein was asked in the company's Q4 conference call in March about plans to enter the U.S. hemp market. He responded, "it's something that we're going to continue watching very closely, and we probably won't telegraph our strategy sort of as publicly as some others have." That tentative reply didn't generate much enthusiasm among investors about Cronos moving anytime soon to compete in the U.S.

This hesitance stood in stark contrast to actions taken earlier this year by two of Cronos Group's peers. Canopy Growth (NYSE: CGC) announced in January that it was building a large-scale hemp production facility in New York state. Tilray (NASDAQ: TLRY) acquired Manitoba Harvest, the largest hemp foods company in the world, which has a big presence in the U.S. market.

But Gorenstein seemed much more confident in his statements last week at an event hosted by the Consumer Analyst Group of New York (CAGNY). He said that Cronos would move aggressively into the U.S. hemp CBD market and indicated that action would be taken in the relatively near future, according to a report by Bloomberg.

That's all Bank of America's Christopher Carey needed to hear to change his tune on Cronos stock. Carey wrote to investors that Cronos entering the U.S. hemp CBD market would be a major catalyst for the stock.

An ace in the hole

There's a big reason why Carey thinks that Cronos can be successful in the U.S., and that reason is the company's big partner Altria (NYSE: MO). The tobacco maker invested around $1.8 billion in Cronos earlier this year in exchange for a 45% stake in the company.

Thanks to the big influx of cash from Altria, Cronos should be in a great position to invest in expanding to the U.S. It seems likely that the company could follow in Canopy Growth's footsteps in establishing a hemp production facility in the U.S. for extracting CBD from hemp bought from U.S. hemp farmers.

Carey wrote to investors that he expects Cronos to heavily leverage its connection with Altria to launch hemp CBD products in the U.S. Altria's tobacco products, including Marlboro and Virginia Slims cigarettes and Skoal smokeless tobacco, are sold in around 230,000 retail locations.

He's probably right with that prediction. Altria CEO Howard Willard stated in the tobacco giant's Q1 conference call in April that his company's big investment in Cronos "was really designed to enable them to make the kind of moves that are necessary to build out a leadership position." Willard's comment came as part of his reply to a question about how Cronos might expand into the U.S. market.

But what about that valuation?

It's still true that Cronos Group's market cap stands at close to $5.7 billion, while the company is likely to generate sales well below $50 million this year. Will Cronos' potential entrance into the U.S. hemp CBD market help justify that sky-high valuation anytime soon? Probably not. The reality is that Cronos stock is likely to be viewed as overvalued for a while.

However, the long-term prospects for the company still appear to be quite good, in my view. With a huge partner at its side and more cash than any other Canadian cannabis producer that isn't named Canopy Growth, Cronos should be set to be a major player in the U.S. hemp market and the global cannabis market over the long run.

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Keith Speights has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.