Last month, Bank of America analyst Christopher Carey upgraded Cronos Group (NASDAQ:CRON) from an underperform rating to a buy, sending CRON stock 11% higher on the news.
Since Carey’s June 4 upgrade of Cronos stock, it’s gone sideways, finishing the month of June at $15.98, a penny less than where it traded after the single-day good news surge.
More critical than Carey’s buy rating was his 54% increase in the 12-month price target of CRON stock to $20 from $13. At current levels, we’re talking about 27% upside over the next year.
In previous articles, I’ve suggested that Cronos Group stock, along with Canopy Growth (NYSE:CGC) and Hexo (NYSEAMERICAN:HEXO) are the three best Canadian cannabis investments. In recent weeks, I’ve also begun to take a shine to both Aurora Cannabis (NYSE:ACB) and Tilray (NASDAQ:TLRY).
So, it’s good to know that at least one analyst believes Cronos Group is worthy of a higher share price. According to The Wall Street Journal, only two analysts have a buy or overweight rating on CRON stock. The other 12 either rate it a hold or worse.
Not to worry.
Here are three reasons Cronos Group looks like a buy.
Altria Knows a Thing or Two
Have you seen those Farmers Insurance ads where actor J.K. Simmons says, “We know a thing or two because we’ve seen a thing or two?” They’re memorable spots.
Well, the day last December that Altria (NYSE:MO) announced that it would invest $1.8 billion in Cronos for 45% of the company with an option to buy another 10% at $19 a share, I just knew the Toronto-based cannabis company was about to go global in a big way.
As a result of Altria’s involvement, I’ve gone as far as recommending risk-averse investors buy MO instead of CRON so you can get paid an excellent 6.6% dividend yield while you wait for its cannabis business to mature.
How many cannabis companies are going to pay you a 6.6% dividend yield while their pathways to profitability appear? Zero.
As Carey said himself in his upgrade, Cronos Group is going to be a vastly different company in the next few years; Altria’s expertise in crop science, distribution, etc., is going to have a lot to do with that change.
A Ton of Cash
Cronos currently has a market cap of $5.37 billion. In the first quarter, it closed the Altria investment. At the end of March, the pot producer had $1.8 billion in cash on the balance sheet. It’s trading at less than three times cash.
By comparison, Canopy Growth is trading at 4.1x its $3.4 billion cash and Hexo is trading at 7.5x its $133.0 million. At least by this valuation metric, Cronos is the cheapest of my three favorite Canadian cannabis stocks.
However, more important than the cash it’s gotten from Altria is the ability to develop new products using Altria’s long history of extending brands to generate higher revenues.
Altria has had to operate within the confines of a very regulated industry with strict laws about advertising to children, etc. If anyone can understand and maneuver through the regulatory hurdles surrounding cannabis, Altria can.
To me, that’s worth a lot more than $1.8 billion in cash. Sure, you can hire experts who can assist in these areas, but it’s helpful to have a partner that can write a big check if necessary. I’m not suggesting that Cronos needs any more cash at this point, but it never hurts to know it’s available if need be.
The Derivatives Market
In mid-May, Cronos announced that it had entered into a multi-year supply agreement with Medipharm Labs (OTCMKTS:MEDIF). The agreement would see Medipharm supply Cronos with $30 million of high-quality private label cannabis concentrate over the next 18 months and possibly an additional $30 million over the next 24 months.
What a lot of Americans might not realize is that Medipharm is based in Barrie, Ontario, less than 20 miles from Cronos’ largest grow facilities in Stayner, Ontario. Having this kind of access to quality concentrates will help it keep on top of demand once products are legally available in December and into 2020
Also, Cronos will supply bulk cannabis to Medipharm’s state of the art extraction facilities to meet some additional processing needs of the company.
“As the industry develops and matures, we see opportunity to work with companies like MediPharm Labs that provide specialized, high-quality services and inputs for our products,” said Mike Gorenstein, CEO of Cronos Group. “Along with our internal capabilities, we are pleased to be working with MediPharm Labs to bring great products to consumers in anticipation of the derivative market launching in Canada this fall.”
While derivative products such as concentrate, edibles, and infused products will be legalized in Canada on the first anniversary of the October 17, 2018 cannabis legalization there, companies have to give the Canadian federal government 60 days notice before selling new products, which puts the availability date into December at the earliest.
Working closely with MediPharm, Cronos ought to be able to capture a chunk of the Canadian derivatives market. Owners of CRON stock should look forward to this relationship delivering revenue growth in 2020 and beyond.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.