Earlier this year, Canadian cannabis producer Cronos (NASDAQ:CRON) was the hottest pot stock on the market, more than doubling in two months from $10 in late December 2018, to $25 by February 2019. Things have turned upside down since. Cronos stock has essentially given up all of its early 2019 gains over the past 6 months.
Today, the stock trades hands narrowly above $11.
So is it time to buy the dip in a secular growth cannabis stock with the multi-billion dollar investment backing of a tobacco giant? Not quite.
I do believe that at current levels, Cronos stock is fundamentally undervalued relative to its long-term growth prospects in the global cannabis market. But I also understand that sentiment is exceptionally dour in the cannabis space right now and that the chart for CRON stock looks broken.
Stocks don’t move just because of fundamentals. They move because of fundamentals, optics and technicals. Right now, only one of those three factors is working in favor of Cronos stock right.
Thus, until the optics and technicals turn a corner, I don’t think Cronos stock is worth buying on this dip.
Cronos Fundamentals Look Good
The long-term growth fundamentals underlying Cronos stock remain favorable and imply that at current levels, the stock is materially undervalued.
For brevity’s sake, here’s the quick rundown. Current consumption trends and legislation movements imply that the global cannabis market has potential to be nearly as big as the global tobacco and alcoholic beverage markets. Those are several hundred billion to trillion dollar markets. The cannabis market should get that big today. As such, with most cannabis companies and analysts pegging the market as nearing $200 billion in size in a decade, I 100% believe that projection.
Cronos is a small player in that market. Competition will only get stiffer as the market gets bigger. But Cronos has the backing of Altria (NYSE:MO), an $85 billion global tobacco company with deep pockets. Those deep pockets should help Cronos capture and sustain respectable share in this market at scale.
Conservatively, I think that share number will come in around 2%. In a $200 billion market, that puts Cronos sales at $4 billion in a decade. Gross margins at scale should be able to run towards and potentially above 55%. Big revenue growth should drive healthy operating leverage, and push the opex rate down to a more normal 30% rate — implying 25% operating margins at scale. On $4 billion in revenue, that implies $1 billion in operating profits. Taking out 20% for taxes, you’re left with about $800 million in net profits.
Applying a market-average 16-times forward multiple to that, a reasonable decade-forward valuation target for Cronos stock is $12.8 billion. Discounted back by 10% per year over 10 years, that equates to a present valuation target of nearly $5 billion — versus a market cap of under $4 billion today.
Cronos Stock Suffers From Bad Optics & Technicals
Although Cronos stock is undervalued, it won’t bounce back simply because it’s undervalued. Instead, this stock needs both favorable optics and favorable technicals to support the turnaround.
Unfortunately, Cronos has neither right now.
On the optics side, everyone is scared of the cannabis space right now. Sales across the board aren’t ramping like investors were hoping for. Global legislation trends are moving at a snail’s pace, and these stocks are priced for global expansion. Margins and cash flows are being hit hard by capacity buildouts and infrastructure investments.
In other words, what you have with pot stocks right now is a bunch of companies that aren’t growing as fast as their valuations say they should, that are simultaneously burning through a ton of cash and that are running at very low margins, with a bleak outlook as to when any of this will change. That’s a horrible optical backdrop. But it’s the optical backdrop that Cronos stock finds itself against today.
Until that backdrop changes, Cronos stock likely won’t stage a big turnaround.
Further, the technicals supporting CRON stock look broken.
The stock has been in free fall since February, and in that free fall, has broken every single important support level. The next big support level shows up at $10 (the Christmas 2018 bottom). After that, it’s $8 (the Halloween 2018 bottom). Until the stock shows it can hold either of those support levels, the technicals won’t support a rebound.
Bottom Line on CRON Stock
The recent selloff in Cronos stock has plunged the stock into fundamentally undervalued territory. That means that, at some point, this stock is a buy on this dip.
But, that point is not today. Instead, the optics and technicals are broken here. Until they become unbroken, it’s best to stay away.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
