Cronos Group (NASDAQ:CRON) in late July announced the purchase of four subsidiaries of Redwood Holding Group. Like other recent acquisitions, the Redwood buy demonstrates how Cronos is taking a distinctly different path to growth than its major competitors. This difference, though, is not reflected in CRON stock at the moment.
In its last earnings period, Cronos Group easily beat analysts’ expectations for revenue, posting $10.24 million (vs. expectation of $7.36 million). This was after a first quarter in which it posted a 120% YoY revenue increase.
Despite these positive revenue numbers, CRON stock is down 50% since February. Some of this is an overreaction to the behavior of CannTrust Holdings (NYSE:CTST). In July, CannTrust was found guilty of growing marijuana in unlicensed rooms. The fallout affected the entire industry, which was already falling from its 2018 highs.
Still, prior to July, CRON stock was down 11.7% while the ETFMG Alternative Harvest ETF (NYSEArca:MJ), lost 4.66%. Cronos Group stock is the second-largest holding in the 38-stock cannabis exchange-traded fund.
Questions abound about the companies short- and long-term profitability. Their PS ratio of 191 doesn’t help matters.
At a quick glance, Cronos may look similar to many established cannabis companies. But as I mentioned above, CRON is taking a different path to growth. My InvestorPlace colleague Will Healy points out that Cronos is under the tutelage of their major investor and tobacco giant, Altria (NYSE:MO). And that path gives me two reasons to be optimistic about their future growth.
An Asset-Light Approach to Growth
Many of the major cannabis companies are making acquisitions to help their cultivation efforts. Cronos is adopting a supply chain that focuses on a network of co-manufacturing joint ventures and partners. Redwood is the latest example. This was the company’s first effort to enter the U.S. marijuana market. The acquisition is consistent with CRON’s attempts to position itself to fit the growing demand for CBD-based beauty products.
Another example of Cronos Group’s innovative approach took place in 2018. At that time, the company entered into a partnership with Gingko Bioworks. This is a bioengineering company that produces cannabinoids through biosynthesis. This partnership is helping CRON reduce the cost of cannabis production and positions them to produce minor cannabinoids such as tetrahydrocannbivarin (THCV) on a large scale. THCV has a number of health benefits, such as its ability to suppress appetite, that are not present in other forms of cannabinoids (i.e., THC or CBD).
CRON is also aggressively carving out a niche in the Canadian derivatives market. This includes products like vaping pens, edibles, and topicals. CRON has agreement in place with third-party suppliers who will use Cronos’ proprietary formulations in their products. Although other companies have a larger addressable market at the moment, these agreements will give Cronos Group a seat at the table.
Cronos is Doing Right by its Shareholders
Most cannabis companies are financing their acquisitions with a secondary stock offering. This nifty accounting trick is common with real estate investment trusts (REITs). However, since a REIT is obligated to pay out a dividend, shareholder value is not diluted.
But the major cannabis companies are not issuing dividends. This means that with every secondary offering they are diluting the value of their shares. Investors are catching on and it is showing up in the stock price for these companies.
Here again, Cronos is doing things differently. They are paying for most of the Redwood acquisition in cash. Specifically, the cash they received from Altria, that made a major investment in Cronos Group in 2018.
According to reports, the company will pay $225 million of the $300 million in cash. The rest will be paid by issuing common shares (valued at $14.74). Even after the purchase, CRON will still be sitting on nearly $1.5 billion in cash. Putting that cash to work is what shareholders expect. Plus, paying in cash means that Cronos is effectively managing its debt load. Cronos’ long-term debt is about $15 million which is pocket change compared to the $700 million that is owed by Canopy Growth (NYSE:CGC).
This is a compelling story that many investors aren’t hearing about yet. And it’s why Cronos stock may be one of the best deals going, not only in the cannabis sector but in the broader market as well.
What’s Next for CRON Stock?
I foresee investors will look to re-enter the cannabis sector as the derivatives market opens in Canada in December. When they do, I believe CRON stock will stand out. One of the major reasons for my conviction is that the company is showing its value to investors. Put simply, when Cronos sees its market cap rise, it will be due to repeatable revenue and share price appreciation, not because of an accounting trick.
As of this writing, Chris Markoch did not hold a position in any of the aforementioned stocks.
