So much for the cannabis craze coming to a close. After a steep drop in late 2018, pot stocks have been on fire to start 2019, with many of them making new highs. Tilray (NASDAQ:TLRY) is up 12% year-to-date. Aurora (NYSE:ACB) is up 40%. Canopy Growth (NYSE:CGC) is up 70%. But, even those big rallies pale in comparison to what shares of Cronos (NASDAQ:CRON) have done in 2019. Year-to-date, CRON stock is up over 100%.
This parabolic rally in CRON stock has left many pundits calling the stock wildly overvalued. Some are calling it the new Tilray, the pot stock that briefly touched $300 in late 2018 and has since settled below $100. Others are saying that the lack of revenues and production capacity at Cronos don’t warrant the rally in CRON stock.
Do these concerns have merit? After doubling in two months, is CRON stock overvalued?
Depends on how you look at it. Broadly speaking, no, CRON stock is not overvalued in the big picture. But, it is overvalued relative to other pot stocks, such as CGC stock. As such, while CRON stock isn’t a bad bet here, it also isn’t the best bet in the pot space. I still think CGC stock is the best pick in this space. But, CRON stock isn’t a bad second choice.
Why Cronos Stock Isn’t Overvalued
Broadly speaking, CRON stock is not overvalued in the big picture.
In the big picture, the fully-legal Canadian cannabis market is just the tip of the iceberg. Eventually, secular shifts in mass perception will push legislation to making recreational and medicinal cannabis legal on a global scale. Once it does, current consumer preference trends in the illicit market imply that the legal recreational and medicinal cannabis market could be really big on a global scale — something like $500 billion big, or roughly comparable in size to the current global tobacco and alcoholic beverage markets.
Canadian cannabis companies, like Cronos, have a headstart in gaining share in that potentially huge global market, given that they are already gaining expertise in producing and selling cannabis across all of Canada. Some of those pot players, including Cronos, have also scored big investments from much larger tobacco and alcoholic beverage companies, and those big investments give companies like Cronos the financial means to capitalize on first mover’s advantage in the global cannabis market.
As such, Cronos is one of a handful of Canadian cannabis companies that could one day reasonably control anywhere from 1% to 5% of the $500 billion global cannabis market. The more likely outcome is in the 1-3% range. Under that assumption, and further assuming alcoholic beverage average 30% operating margins at scale and that it takes 10-15 years to get there, I think Cronos is worth between $4 billion and $7 billion today.
Cronos currently has a market cap narrowly under $4 billion. Thus, CRON stock is not overvalued in the big picture.
Why Cronos Stock Isn’t the Best Pick, Either
Although CRON stock isn’t overvalued, that doesn’t mean this is the best play in the cannabis space, either.
From a valuation perspective, CRON stock isn’t the most attractively valued pot stock in the space.
Canopy just reported a blowout quarter wherein the company sold over 10,000 kilograms of cannabis globally (or roughly 40,000 kilograms, annualized). That was up by a factor of over 4.5 quarter-over-quarter. Aggressively assuming Cronos had a similar blowout quarter, then Cronos maybe sold about 2,300 kilograms of cannabis this quarter (or roughly 10,000 kilograms, annualized).
Canopy’s market cap is roughly $15 billion. Cronos has a market cap of roughly $4 billion. Thus, CGC stock is being valued by the market at roughly $375,000 per kilogram of cannabis, annualized. CRON stock is being valued at roughly $400,000 per kilogram, meaning CRON stock is slightly more expensive on a per kilogram basis.
That doesn’t make much sense. Canopy is much bigger than Cronos, with a stronger balance sheet, bigger reach, and a significantly larger sales and profit base. Thus, if anything, CGC stock should be more expensive than CRON stock.
That isn’t the case. As such, while CRON stock isn’t overvalued, it isn’t the best pick in the pot space, either. That title still belongs to CGC stock.
Bottom Line on CRON Stock
Broadly speaking, cannabis stocks are not in a bubble. The run up in pot stocks in 2019 is supported by strengthening of global growth fundamentals, including the legalization of hemp in the U.S.
Given favorable long-term growth fundamentals, CRON stock is not overvalued here. But, it also isn’t the best pick in the pot space. That title belongs to Canopy. Thus, for investors seeking exposure to the cannabis space, CGC is still the best pick. CRON stock isn’t a bad second pick, though.
As of this writing, Luke Lango was long CGC.