The market seems to have decided that cannabis stocks like Cronos Group (NASDAQ:CRON) were in a bubble. Pot stocks have been absolutely hammered for the last few months, and Cronos Group stock has been no exception. CRON stock has dropped nearly two-thirds from its 52-week high, and now trades at 2019 lows.
Again, CRON isn’t the only cannabis play taking a beating. Canopy Growth (NYSE:CGC), Aurora Cannabis (NYSE:ACB), and Tilray (NASDAQ:TLRY) all are down at least 62% from 52-week highs.
That obviously doesn’t mean the sector is headed to zero. Presumably, at some point, buyers will step in. There’s still a long-term opportunity in cannabis, even if early results in Canada look disappointing. Valuations clearly got out of hand, but at least on an EV/revenue basis are starting to come in.
But the problem for Cronos Group stock in the near-term still holds. As I wrote in May, the company still hasn’t given investors a coherent narrative for actually owning CRON stock. The best thesis I’ve come up with is that Cronos stock is the cannabis play for investors who believe cannabis plays are overvalued.
That might well be wise long-term — I largely agree with the strategy so far — but it’s not going to help much any time soon. With a chart that is a textbook ‘falling knife’ and profitability still years out, there’s not much reason to predict a bottom in CRON stock just yet.
The Problem With CRON Stock
“Now, we understand that many investors are modeling cannabis companies off of their production capacity. However, our business model is not to be the farmer.”
That quote comes from Cronos CEO Mike Gorenstein on the Q2 conference call in August. And it highlights the near-term problem for Cronos Group stock.
Any investor trying to time the bottom here in cannabis stocks has to believe that the sell-off has gone too far. That investor may well believe that past highs — $20+ for CRON, $50+ for CGC, etc. — were too high. But the thesis would be that what began as a reasonable correction to valuations has turned into a stampede of selling that ignores the broader opportunity.
If that investor wants to buy a cannabis stock right now, it’s exceedingly difficult for them to choose CRON. If the opportunity long-term still is intact, the play is to go with Canopy or Aurora, two companies who are aggressively going after multiple markets in the industry.
As Gorenstein noted, many of those investors are valuing pot stocks off production and/or revenue. Because of its disinterest in developing production capacity, CRON stock screens poorly on both metrics (at least on a relative basis).
Even after acquiring Redwood, the company does have US$1.5 billion in cash on its balance sheet — almost half a current market capitalization of US$3.2 billion — but that hardly makes Cronos Group stock a value play. CRON still trades at 11x EV/revenue using 2020 consensus estimates.
Profitability remains several quarters out, too. Fundamentally, this is a stock that lacks a story and a catalyst. Without either, it’s tough to project a near-term rally.
The Long-Term Case for Cronos Group Stock
To be clear, these are short-term issues. Cronos Group’s cash balance gives the company time to execute its strategy. And I still believe that strategy is wise. It’s an echo of what its largest shareholder, tobacco giant Altria (NYSE:MO), has done. Let farmers farm while the processor uses capital for branding, development, and distribution in higher-margin end markets.
With oversupply concerns already rampant, it’s somewhat surprising that Cronos Group hasn’t received a little more credit for that strategy. But it hasn’t, and it’s possible it won’t until it proves itself.
And even in a best-case scenario, that’s going to take some time. In the meantime, the chart is ugly, the sector is collapsing, and there aren’t any external catalysts on the horizon.
The U.S. House of Representatives did pass the SAFE Banking Act, a presumed step toward potential legalization. Last year, such a development likely would have sent cannabis stocks soaring. This year, it barely registered: the sector-wide sell-off has continued.
Investors need to look at that price action for all cannabis stocks, but especially CRON. It’s not going to bottom before its sector does. And given its strategy, it’s likely going to be late in joining any rally. The long-term strategy is intriguing, and valuation is getting at least palatable. Still, there’s absolutely no need to rush.
As of this writing, Vince Martin has no positions in any securities mentioned.
