There Are Better Pot Plays Than CRON Stock

Cronos (NASDAQ:CRON) stock is down about 43% since March. Although up more than 22% year-to-date, the Canadian marijuana stock has fallen in the past five months from a high of $24.37 a share down to $13.81 as of this writing. With confidence in the cannabis sector waning, investors are thinking twice before placing a bet on the industry.

Cronos stock

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But is Cronos stock different? Many of the company’s peers have experienced material headwinds. Cronos has several key advantages, including a strategic investment from tobacco giant Altria Group (NYSE:MO).

The caveat is that Cronos stock trades at a substantial valuation to its marijuana stock peers. In an overvalued sector, investors are taking a big risk paying such a high premium. So what is the verdict? With the next earnings report coming out this month, read on to see if CRON stock is a buy today.

A Closer Look at CRON Stock

For the first quarter of 2019, sales were $6.47 million, a 120% increase from the first quarter of 2018. With ramp-up in production and infrastructure, the company posted higher operating losses than in the prior quarter. But with plenty of cash from the Altria investment (more below), the company can afford to sustain these operating losses.

The question is not the current performance of Cronos, but growth potential in non-Canadian markets. Cronos has exposure to markets outside North America, but less so than peers such as Aurora Cannabis (NYSE:ACB). The company has supply agreements with pharmaceutical companies in Germany and Poland, and is working on obtaining a license in Colombia. Israel and Australia are additional markets. But for all intents and purposes, CRON stock is a play on the North American cannabis growth story.

With regards to the United States, we are years away from full legalization. While many states have legalized recreational marijuana, federal bans are still in place. Until Congress passes legislation such as the SAFE Banking Act, banks will not provide the industry financial services. Without access to basic banking, the American cannabis sector cannot scale. But once marijuana is fully legal across all 50 states, the market is up for grabs. Thanks to the Altria investment, Cronos has plenty of capital to scale into a major marijuana purveyor.

Like competitors Canopy Growth (NYSE:CGC), Cronos has a deep-pocketed strategic partner. Altria Group bought a 45% stake in the stake in the company via a $2.4 billion private placement. Warrants give them the option to acquire an additional 10%. With the Altria partnership, Cronos gets the expertise and infrastructure of a tobacco company to help scale up operations.

Dilution, Valuation Among CRON Stock Risks

Like its marijuana stock competitors, Cronos has engaged in dilutive equity and debt offerings to fund operations. The Altria deal alone was highly dilutive, increasing the share count by about 82%. The issuance of warrants to Altria bumped up dilutive securities nearly threefold to 110.5 million equivalent shares. The issuance of dilutive securities minimizes potential upside for those entering the stock today. One positive is the high exercise price of the Altria warrants. The warrants have a strike price of $19 a share, an approximately 38% premium to the current trading price.

Even among its peers, CRON stock trades at a high valuation. Shares in the marijuana stock trade at an Enterprise Value/Sales (EV/Sales) ratio of 217.6. Here are the EV/Sales ratios of the company’s main competitors:

Aurora Cannabis (NYSE:ACB): EV/Sales of 54.26

Canopy Growth (NYSE:CGC): EV/Sales of 54.28

Hexo (NYSE:HEXO): EV/Sales of 32.8

Tilray (NASDAQ:TLRY): EV/Sales of 68.6

Even among a richly-valued sector, CRON stock trades at a substantial premium. While the partnership with Altria may give them a leg up once U.S. federal marijuana laws are relaxed, it likely does not justify the current premium.

Cronos has more room to fall if investors continue to bail out of the cannabis space. With upside impacted by the Altria warrants, paying a substantial valuation premium for CRON stock does not seem worthwhile.

There Are Better Ways to Play the Cannabis Growth Story

With full commercial marijuana in the United States years away, there is plenty of time to place your bets on the cannabis sector. With the market overvalued, it may pay to wait things out until a screaming buy emerges. This is especially the case with Cronos.

While the company may see parabolic growth in the next few years, much of this is reflected in the current share price. The partnership with Altria gives the company a solid strategic partner, but the highly dilutive nature of the deal minimizes potential upside. Investors may find opportunity betting on the cannabis sector. Cronos is the not the best marijuana stock out there. Take a pass on CRON stock.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

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