If you own Aurora Cannabis (NYSE:ACB) stock, Cowen & Co. analyst Vivien Azer’s February 5 comments about the Canadian company, were music to your ears. Also, getting some love from the analyst was Cronos Group (NASDAQ:CRON) and CRON stock, which she believes is doing an excellent job in the global medical cannabis market.
While Azer sees Aurora becoming profitable ahead of other large cannabis producers, including Canopy Growth (NYSE:CGC) and Aphria (NYSE:APHA), it’s her comments about Cronos’ asset-light model that’s got me interested. She’s got a good track record on cannabis stocks, ranked #64 out of 5,220 analysts on TipRanks.
Back in December, Azer raved about Cronos’ substantial investment from Altria (NYSE:MO). “While the potential uses of cannabinoids are vast, Cronos believes the key to successfully bringing cannabinoid-based products to market is in creating reliable, consistent and scalable production of a full spectrum of the roughly 100 cannabinoids, not just THC and CBD,” Azer wrote in a note to clients. “Together, Cronos can leverage Altria’s operational capabilities and expertise in order to create value-added form factors while focusing on ingredient composition without reliance on massive cultivation (farming) infrastructure.”
Translation: Cronos sees much greater value focusing on the finished goods and not so much on the cultivation of dried leaf.
Shift in Focus
If I didn’t know any better, I’d say that’s a page right out of Altria’s playbook. The cigarette maker owns none of the tobacco it sources. Its strength is manufacturing the cigarettes in mass quantities and efficiently getting them to customers.
It’s a big reason why I believe Altria’s 45% stake in Cronos was a steal at $1.8 billion. “While Cronos doesn’t have anywhere near $1.5 billion in revenue [Altria paid more than $14 billion for 35% of Juul] — the cannabis company had just CAD$3.8 million in its most recent quarter — it gives Altria a platform for growth in a market that’s destined to be much bigger on a global basis than e-cigs could ever hope to be,” I wrote on Dec. 31.
Source: New Frontier Data
Long before the recreational use of marijuana was legalized in Canada, I argued that tobacco companies would be the ideal group to solve supply issues that were cropping up in 2014, and still exist today.
So, the fact that Altria’s now involved is great news for the cannabis industry as a whole. And great news for CRON stock holders.
A Safer Alternative
Although Cowen’s Azer likes Cronos Group stock, she feels the valuation is much too frothy. Currently trading above CAD$30, Azer has a 12-month target price of CAD$29, which means one of three things is going to happen.
The first scenario is CRON stock goes sideways for the next 12 months — it’s up 119% year to date through March 6. The second scenario is that it falls in value at which point she’d be a buyer. In the third, she’s wrong about the valuation and it continues to move higher.
I don’t know about you, but a coin toss is the only way I’m going to be able to decide the potential outcome. Which means there ought to be a safer alternative. And there is.
Last July, I recommended that anyone interested in Canopy Growth stock should hedge their bets by putting 50% of any dollar amount contemplated in Constellation Brands (NYSE:STZ), 25% in Canopy Growth, and the remaining 25% into the Horizons Marijuana Life Sciences Index ETF (OTCMKTS:HMLSF), which has Cronos, Canopy, and Aurora as the top three holdings.
If you followed this route, a $10,000 investment is worth $10,590 through March 7. While that 5.9% gain is not exactly a home run, I don’t think anyone expected Constellation Brands to lose so much value — more than 23% — when Canopy Growth itself is up 50% over the past eight months. The Nasdaq Composite index is down 4.3% in the same period.
The valuation mismatch should disappear over the next 12 months. When it does, investors will be way ahead.
How to Play CRON Stock
My three favorite cannabis stocks are Cronos, Canopy Growth, and Hexo (AMEX:HEXO).
Following my suggestion for Canopy Growth, I would do the same for Cronos and Hexo, which means adding three new holdings, including Altria. Only the weightings would be a little different.
In this case, I would weight each of the individual cannabis companies at 15%, Constellation Brands and Altria at 20% each, and the remaining 15% in the Horizons ETF.
When the you-know-what hits the fan, your downside will be better protected.
As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
