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Why Investors Should Continue to Avoid Cronos Stock

The past 12 months have been rough for shares of Canadian cannabis producer Cronos (NASDAQ:CRON). No matter what time frame you look at, CRON stock has been pummeled. In the past five days, shares are down 2%. Over the past month, they are down 17%. Year-to-date, Cronos stock has shed 16%. It’s down 12% over the past year. Worst of all, CRON stock presently trades 65% off its early 2019 highs.

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Source: Shutterstock

CRON stock isn’t alone here. It’s been a bloodbath across the entire cannabis sector over the past year. All the big names — Canopy Growth (NYSE:CGC), Tilray (NASDAQ:TLRY), Aurora (NYSE:ACB) and Aphria (NYSE:APHA) — are down more than 60% from their early 2019 highs.

At this point, three questions should come to mind. One, why have pot stocks crashed? Two, will pot stocks rebound? And three, will CRON stock rebound?

The answers are fairly simple. Pot stocks have crashed because of a flurry of negative press in the cannabis industry, which has broadly depressed investor sentiment and weighed on rich pot stock valuations. Pot stocks will rebound in the long term, but not anytime soon. CRON stock will rebound in the long run, too, but such a rebound likely won’t materialize soon.

As such, for the foreseeable future, investors should stay away from Cronos stock. This is a falling knife that will likely fall more before it rebounds.

The Pot Stock Bloodbath

In short, pot stocks have crashed over the past several months because the global cannabis market has been an absolute mess, and pot stocks weren’t priced for this mess.

The global cannabis market right now is in disarray. In Canada, legal market demand has stagnated, as persistent supply shortages and huge legal licensing and tax costs have kept the bulk of demand in the black market. In response, Canadian cannabis producers like Cronos are spending an arm and a leg to build out supply while simultaneously discounting their weed so as to compete with black market prices — the sum of which is creating significant margin pressures across the whole industry.

Meanwhile, in America, there has been a notable lack of legislative progress. At the same time, the vaping crisis has dampened enthusiasm for cannabis vaping products globally.

Pot stocks weren’t priced for this disarray. At its peak, CRON stock was trading at over 150-times forward sales. That multiple only works for a stock if everything goes right. Everything hasn’t gone right. Naturally, cannabis stocks have collapsed.

Pot Stocks Will Rebound … Eventually

In the big picture, pot stocks will rebound for two big reasons — near-term headwinds will pass and the long-term fundamentals remain robust.

The black market won’t forever dominate the legal market. This is just a byproduct of the legal market struggling at its first at-bat in the cannabis industry. Over time, governments will do a great number of things to help the legal market win share, including reducing licensing and regulatory fees, increasing black market penalties and reducing taxes. Further, legal players are in the early stages of building out capacity. At scale, they will have much more growing capacity and supply than black market players, so near-term supply shortage issues will pass.

Meanwhile, given underlying favorable consumption trends, it really is only a matter of time before the U.S. market becomes fully legal on a national level. Other developed economies will follow suit. Within the next decade, cannabis will likely be legal in most major developed economies.

Further, today’s vaping crisis is just a headline risk. Over time, vaping may die. But, cannabis consumption won’t die. According to a University of Michigan study, consumers like to smoke cannabis nearly as much as they like to drink. Consumers will just pivot to alternative methods of cannabis consumption, including edibles, oils, etc.

The cannabis market is still in its early stages, and many of today’s pot stocks will be important players in that huge market. Long term, then, pot stocks will bounce back.

Cronos Stock Won’t Rebound Yet

Cronos stock should bounce back long term, too. But the recovery rally likely won’t start soon.

The math for long-term upside is simple. Most estimates peg the global cannabis market as being $200 billion large by 2030. That seems conservative to me, given that the global alcoholic beverage market is a multi-trillion dollar market, and cannabis consumption among younger audiences is nearly as common as alcoholic beverage consumption. Nonetheless, $200 billion seems like a safe projection for the cannabis industry in a decade.

Cronos is a small player in that market. But, it also has the financial backing of global tobacco giant Altria (NYSE:MO). Consequently, Cronos should leverage this powerful partnership to command respectable market share in the long run.

Reasonably, I think CRON’s market share will come to about 2% in the long run. In a $200 billion market, that equates to $4 billion in revenues by 2030. Operating margins should hover around 25% at scale, similar to what they are in the alcoholic beverage world, implying $1 billion in operating profits by 2030. Taking out 20% for taxes, Cronos could be looking at $800 million in net profits in a decade. Based on a market average 16-times earnings multiple, that equates to a 10-year-forward valuation target for CRON stock of $12.8 billion.

Cronos has a $3 billion market cap today. Thus, long-term upside is compelling.

But, CRON stock won’t realize that long-term upside today. So long as optical risks stick around, investors will have a tough time paying 70-times forward sales for this stock. As such, the best thing to do is stay away for now, let the optical noise pass and buy the dip once the stock shows signs of bottoming.

Bottom Line on CRON Stock

Cronos stock isn’t going to buck the pot stock trend. So long as pot stocks remain depressed, CRON stock will remain depressed, too.

Pot stocks will bounce back at some point. But, not here, and not now. As such, the best thing to do with CRON stock is to watch the drama play out from the sidelines and buy the dip once the drama passes.

As of this writing, Luke Lango was long CGC. 

Article printed from InvestorPlace Media, https://investorplace.com/2019/10/why-investors-should-continue-to-avoid-cronos-stock/.

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