Cronos Group (NASDAQ:CRON) shares have struggled of late. Since early March highs, Cronos stock is down about 35%.
Cronos stock managed to put together a modest rally last month, but it has faded. CRON sits at a one-month low at the moment.
To be sure, CRON stock isn’t alone. Other cannabis majors are scuffling. Canopy Growth (NYSE:CGC) has dropped steadily since late April, losing about a quarter of its value.
For the biggest cannabis stocks, investor patience is drying up. Why that is remains unclear. Valuation could be a concern. It’s likely that there’s a “OK, what’s next?” response after Canadian legalization in October.
The problem for Cronos Group stock, however, is that even when sentiment returns, it’s not clear what the company can do to spark investor enthusiasm.
The near- to mid-term worry is that if cannabis stocks continue following, CRON stock will too. And if they rise, Cronos stock may well underperform peers until the wisdom of its plans become more clear – and Cronos starts showing real success.
The Canada Problem for Cronos Stock
It’s become increasingly clear that the Canadian market isn’t big enough and that there are real worries about too much supply in cannabis flower more broadly. As I’ve noted before, prices have crashed in U.S. regulated markets due to oversupply.
Cronos seems to be operating on similar principles. Despite its US$1.8 billion investment from Altria (NYSE:MO), its production capacity might not even make the top ten in Canada, as the Motley Fool has noted. Even with that cash on the books, Cronos isn’t racing to build out its production capabilities.
That strategy makes some sense, particularly if as feared the Canadian market simply isn’t big enough. Oversupply in dried flower is a real concern. But as far as CRON stock goes, it raises the question of what catalyst might arrive any time soon.
Cronos might be right in playing the long game. Investors – and particularly cannabis stock investors – haven’t shown that same patience in recent months.
As CEO Mike Gorenstein put it on the Q1 conference call, “Like Altria, we believe that the best way to create value through the supply chain is by working with contract farmers and not being farmers ourselves.”
Cronos simply isn’t all that interested in producing dried cannabis flower. It would rather let others spend the money to create that supply, assuming it can then buy flower at cheaper rates down the line.
Instead, the company is focused on derivatives and R&D. It’s working with Ginkgo Biosciences to create new strains of cannabis that can yield purer and easier-to-extract THC and CBD.
Its new Cronos Device Labs in Israel will focus on fine-tuning vaporizers for varying customer demands. Production in Colombia is focusing on hemp over cannabis, with Gorenstein predicting on the Q1 call that CBD would outpace THC in terms of growth in the coming years.
The Altria partnership should give Cronos an edge in these areas, given that tobacco company’s long history with regulators. But there’s risk here as well.
The efforts with Ginkgo may not pan out. Even if they do, the new strains may not be all that valuable, if ‘natural’ strains are abundant and cheap as other companies build out capacity. Vaporizer demand may be lower than expected.
There’s certainly a risk that while Cronos plays around the edges of the market, rivals like Canopy and Aurora simply overpower the market. Canopy has more cash thanks to its deal with Constellation Brands (NYSE:STZ,NYSE:STZ.B).
Aurora will give its stock to any company that will take it. If an investor believes that cannabis production will be big business globally, it’s tough to believe that Cronos will be the big winner.
The Long-Term Case for Cronos Stock
From a long-term standpoint, Cronos’ strategy does seem wise. It’s a good idea to keep US$1 billion or so in the bank in an industry in upheaval.
Canadian suppliers are going to go bust; that’s simply the nature of any growing market. Unexpected new markets may emerge elsewhere. Keeping capital on hand enhances flexibility, which seems like a compelling attribute to have as cannabis legalization (both recreational and medical) expands.
Similarly, focusing on higher-value-add and higher-margin products makes sense. One need only look at the difference in valuation between Altria and Pyxus International (NYSE:PYX), an Altria grower, to understand what that will be the case in cannabis as well.
The issue over the next 1-3 years, however, is that the strategy appeals to those of us (myself included) who think cannabis stocks are too expensive to begin with.
Again, Cronos is set up for a future where oversupply hits prices and/or the global cannabis market moves slower than bullish investors expect. In both scenarios, cannabis stocks come down – and it’s unlikely, though not impossible, that CRON stock emerges unscathed.
In a sense, Cronos stock is the pot stock for investors who question whether pot stocks have rallied too far. If those investors are right, they’re betting off staying as patient as Cronos is willing to be. As such, even with CRON stock cheaper, there’s seemingly little need to rush in.
As of this writing, Vince Martin has no positions in any securities mentioned.