Shares of Canadian cannabis producer Cronos (NASDAQ:CRON) have struggled over the past few months, alongside the entire pot sector, amid weak earnings from the group, sluggish sales trends in the core Canadian market, and C-suite turmoil across many of the industry’s important players. Net net, Cronos stock has dropped 18% over the past three months.
But, that’s actually a good run over the past three months relative to other marijuana stocks. Industry leader Canopy Growth (NYSE:CGC) is down 35% over that same stretch. The two other big players in this space, Aurora (NYSE:ACB) and Tilray (NASDAQ:TLRY), are both down more than 20%.
Thus, although it’s down 18% since late April, Cronos stock has actually outperformed its cannabis peers.
That doesn’t make any sense. Cronos is the smallest of the Big 4 pot stocks. They also posted the slowest revenue and volume growth last quarter. Further, CRON stock is more richly valued than everyone else in this space by a mile. Sure, some of that premium is warranted by the strong balance sheet. But, even on an enterprise value basis (which accounts for that strong balance sheet), CRON stock is still ridiculously overvalued relative to peers.
As such, I don’t really understand the relative out-performance in CRON stock over the past few months. I know it all comes back to the fact that Altria (NYSE:MO) put a bunch of money into this company. But, the market is overvaluing this investment. The medium-term upside from the investment is already fully priced in. As such, the medium term upside on Cronos stock will continue to be capped by valuation friction.
Cronos Has Its Strengths
It goes without saying that Cronos has its strengths. Indeed, ignoring valuation for a moment, CRON stock has the characteristics of a potential long term winning investment.
First, Cronos is one of the more important players in the booming cannabis market. Over the next decade, this market will grow by leaps and bounds. Current consumption trends younger consumers are twice as likely to consume cannabis as are their parents.
Monthly cannabis consumption rates among high school students are now nearly equal to monthly alcohol consumption rates, which implies that young consumers enjoy consuming cannabis nearly as much as they like to drink. Couple this consumption trend with eroding negative stigmas and legislation globally that is progressing towards legalization, and it becomes obvious that the global cannabis market will one day be huge.
Second, Cronos has what only one other notable marijuana company has, and that’s a multi-billion dollar investment from a consumer goods company. Tobacco giant Altria recently poured $1.8 billion into Cronos, following Constellation Brand’s (NYSE:STZ) $4 billion investment in Canopy. This huge investment shores up the balance sheet and gives Cronos the necessary firepower to compete with bigger peers at scale.
Third, Cronos is making all the right moves to optimally capitalize on surging cannabis demand. In particular, the company is aggressively pivoting into the development of weed vaporizers. Vaporizers are huge right now. Nearly 40% of teens have used a vape device over the past year. That’s why many think that weed vaporizers are the future of cannabis.
As such, Cronos pivoting into this space is a smart move that could yield meaningful long term benefits. Broadly, there’s a lot to like here. Indeed, ignoring valuation for a moment, CRON stock looks pretty attractive.
Cronos Stock Is Overvalued
The reality is that we don’t live in a world where valuation is a thing. Instead, we live in a world where valuation is everything. Once you incorporate valuation into the CRON stock debate, the bull thesis goes out the window.
Cronos sold just over 1,100 kilograms of cannabis last quarter. That pales in comparison to the 9,000-plus kilograms of cannabis Canopy and Aurora sold last quarter. Yet, CRON stock has a market cap of nearly $5 billion, which isn’t that far off from Aurora’s $6.5 billion market cap or Canopy’s $11.5 billion market cap.
On a per kilogram of weed sold last quarter, the market is valuing CGC stock at $1.2 million and ACB stock at $700,000. CRON stock’s market cap per kilogram of weed sold last quarter is a whopping $4.2 million.
To be sure, some of that premium valuation is warranted by the $1.8 billion in cash sitting on the Cronos balance sheet. But, even if you incorporate that by using enterprise value metrics, Cronos stock is still way overvalued relative to peers. Cronos has a forward EV-to-sales multiple of over 20, while the median forward EV-to-sales multiple across the cannabis industry is about 6.
Overall, then, Cronos stock is simply way overvalued relative to peers, meaning that the “buy the dip” thesis in CRON stock continues to lack conviction.
Bottom Line on CRON Stock
Ever since the Altria investment, Cronos stock has been awarded an unjustifiably large valuation premium by the market. That unjustifiably large valuation premium has been unwinding over the past few months. It will continue to unwind over the next few months, too. As it does, CRON stock will fail to stage a meaningful rally.
As of this writing, Luke Lango was long CGC and ACB.
