Cronos Group (NASDAQ:CRON), a top Canadian cannabis operator, has been showing some weakness lately. Since early March, CRON stock has gone from $23.70 to $18.10, or a drop of about 24%.
This sudden volatility contrasts with strong optimism earlier this year. However, Cronos Group stock is certainly not alone. Keep in mind that other marijuana shares have also been under some pressure lately or have flat-lined …
But among the top players, CRON incurred the steepest drop. So what’s going on?
A few things: its latest earnings report was a disappointment, and Wall Street analysts have shown some bearishness. Canaccord Genuity, for instance, changed its rating from “hold” to “sell,” and put the price target at $17. This implies a 6% downside from current levels. In fact, Jefferies analyst Owen Bennett also has the same price target.
Then what now for CRON stock? To see, let’s take a look at the pros and cons:
CRON Stock Pros
Secular Trend: The global market opportunity for cannabis is enormous, as there will likely be more countries that push for legalization. A research report from the United Nations states that the spending is at a whopping $150 billion (this also includes the illicit market) and about 180 million people consume cannabis. In the meantime, the main opportunity is in Canada, which legalized cannabis last year for recreational use. Based on research from Deloitte, the market could hit as much as 4.3 billion CAD this year. Even though the latest earnings report for CRON stock did not impress Wall Street, the numbers were still eye-catching. Consider that revenues soared by 248%.
CBD Opportunity: Cannabidiol (CBD) is a compound, found in the sativa plant, that does not produce a high. Medical research demonstrates that it features effective therapeutic properties, such as for mitigating pain. The CBD market is likely to be another strong driver for marijuana stocks. The reason is that last year Congress passed the Farm Bill, which removed this compound from the illegal substance list. So how big could this market be? Interestingly enough, Brightfield Group estimates the size in the U.S. hitting $22 billion by 2022. CRON stock is poised to benefit. For the past few years, the company has invested heavily in its CBD business. For example, it struck a partnership with Ginkgo Bioworks, which has developed a technology to create the compounds at scale.
Altria: CRON also recently struck an agreement with Altria Group (NYSE:MO) for a $1.8 billion investment (giving up a 45% stake). Yet the deal was more than just about money. MO will help significantly increase distribution as well as assist with developing consumer products and putting together effective marketing campaigns. The Altria investment is also a major validation of CRON, carefully picking it ahead of its rivals.
CRON Stock Cons
Production: As seen with the latest earnings report, production has been lackluster for CRON, at least compared to its rivals. The company reported more than 1,000 kilograms. By comparison, CGC was over 10,000 and Aurora came in at about 7,000. But with its resources from MO, Cronos has the ability to catch up. Although, it better do so with more urgency.
Valuation: Using traditional valuation metrics really does not make sense with Cronos Group stock. For example, during the latest quarter, the company posted revenues of only $5.6 million but the market cap was at $6 billion! Given the expectations, there is not much room for error. Besides, with the strong growth and the dynamic changes in the market, there will be much pressure on management to execute.
Supply & Demand: With the money flowing into the industry, overall production will increase at a rapid pace. But as with any agricultural market, there’s the potential of an oversupply. True, there are few signs of this now. However, this could be a risk factor in a few years from now. Next, the investor sentiment for the cannabis market does appear to be excessive. As we’ve seen with other similar situations — say with the dot-com boom — there is often a bust.
Bottom Line on Cronos Group Stock
Even with its issues, CRON will likely remain one of the top operators in the market. And again, scale is incredibly important, as demand will probably remain strong for the long haul. The CBD opportunity could also provide another strong boost for growth.
True, the valuation is high and the volatility will continue, but for investors looking at the cannabis market, it does appear that the pros outweigh the cons for now.
Tom Taulli is the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.