Even Contrarian Investors Should Hold off on CRON Stock for Now

Advertisement

On Nov. 13, Cronos Group (NASDAQ:CRON) reported Q3 financial results. Wall Street raised questions as the company announced lower-than-expected revenue. And while investors continue to hit the brakes on cannabis stocks, on Nov. 14, CRON share price hit a 52-week low at $6.65.

Even Contrarian Investors Should Hold off on CRON Stock for Now

With a market cap of $2.3 billion, Cronos Group stock is one of the largest Canadian marijuana names. In 2019, most marijuana stocks have been extremely volatile. Year-to-date, Cronos Group shares are down about 35%.

Now that the earnings season is behind us, let’s try to determine whether Cronos Group stock is worth buying at these levels.

CRON Stock’s Q3 Earnings Failed to Impress

Like its peers, Cronos Group has three key target markets: Canadian consumers (i.e., recreational users); Canadian medical; and international medical.

Net revenue was CAD$12.7 million. Although CRON stock’s quarterly revenue increased 24%, driven by higher volume, it was still below the estimate of CAD$14.14 million.

During the quarter, Cronos Group also finalized the acquisition of hemp CBD company Redwood in the U.S., a deal that brought in $0.9 million of sales during the quarter.

However, it reported significantly lower quarterly cannabis oil sales. The fact that Cronos Group showed no quarterly international medical cannabis revenue raised eyebrows.

The group’s total operating expenses rose nearly five times to CAD$34.8 million, mostly due to a surge in general and administrative expenses.

Although CRON stock’s per-share earnings surprised on the upside, it was only due to the revaluation of derivative liabilities. Our readers may well remember that in December 2018, tobacco giant Altria (NYSE:MO) group invested $1.8 billion in Cronos Group and took a 45% stake in the company.

Now, due to the recent price decline in CRON stock, the warrants issued to Altria aren’t worth as much as almost a year ago. Hence was the positive surprise in the earnings result.

Oversupply of Cannabis in Canada

There is a wide range of economic, cultural, and legal issues affecting the marijuana industry. One of the most important points to remember is that cannabis is an agricultural commodity.

Quarterly performances of companies like Cronos Group give investors important clues as to how the demand and supply equation is evolving. In Q3, CRON management highlighted a significant supply surplus in the Canadian market.

Canadian recreational users are the most important target for the industry. In October, the Cannabis Council of Canada, which represents 35 federally licensed cultivators, highlighted that the Canadian legal retail market has an oversupply of weed.

Statistics Canada has also released the quarterly National Cannabis Survey. As data for Q3 from the cannabis industry shows, Canada is still a relatively small market.

According to the report, “[f]rom mid-August to mid-September, nearly 5.2 million or 17% of Canadians aged 15 and older reported using cannabis in the previous three months. This was unchanged from one year earlier (before legalization).”

Over the past year, investors have noted that Cronos Group’s sales to the medical cannabis market are low. But its recent results show that its sales in the recreational market are not very strong, either. CRON’s shares of Canada’s recreational market is about 2%.

Lower Prices and Cronos Stock

In addition to an oversupply, Cronos Group’s earnings results also showed further price compression in Canada. This is indeed in line with similar results from its peers, including Aurora Cannabis (NYSE:ACB), Canopy Growth (NYSE:CGC), HEXO (NYSE: HEXO) and Tilray (NASDAQ:TLRY).

At present, the Canadian black market is still thriving, i.e., the transition from the illegal market to the legal one is rather slow. One of the most important reasons for this sluggish move to legality is price.

For Q3, the average cost of a gram of legal cannabis was CAD$ 10.23, compared to CAD$5.59 for illegal weed. This big price gap between legal and illicit marijuana is quite a concern for stocks like CRON.

Another point of worry for pot producers is that there has been a sequential quarterly decline in the per-gram price of legal pot, from CAD$10.65 in Q2 to CAD$10.23 in Q3. Such a drop in price takes us back to the importance of oversupply issues in this agricultural commodity.

In June 2019, legal sales of adult-use cannabis hit CAD$85 million. Respective numbers for May and April were CAD$79 million and CAD$67 million. A basic calculation would show that the total recreational sales number for 2019 is likely to be around CAD$1 billion maximum. And not everyone is convinced that Canadian recreational pot sales will remain strong.

This decline in price marks the first drop in legal marijuana prices since legal sales began last year in October 2018.

In the quarterly update, Cronos Group reported a decline of 42% in its average selling prices. Thus, how can a producer like CRON maintain high margins in an industry that does not have meaningful growth potential?

Where CRON Stock Price Is Now

In general, marijuana companies started 2019 on a strong note. However, investors haven’t been very bullish on the industry in recent months. Especially since mid-March, many cannabis stocks, including CRON stock, have fallen from grace.

Over the past year, Cronos Group stock is down about 16%. After starting 2019 around $10, on Feb. 4, CRON stock reached  an all-time high of $25.10.

The mixed Q1, Q2, and Q3 results have put further pressure on Cronos Group stock and other marijuana stocks. Currently CRON stock is hovering around $6.8.

The downtrend is a stark reminder that CRON’s all-time high of about $25 may not be tested again any time soon. Many investors are now wondering if the bears may possibly push the shares below $6.

Cronos Group stock’s technical charts look weak, pointing to the possibility of longer-term declines around the corner. Expect nearer-term trading to be choppy at best.

If you’re still upbeat on CRON stock, you might consider waiting for the shares to drop to around $6.50. However, investors who buy CRON in the near-term should expect to hold the shares for several years.

Short Interest in CRON Stock

As part of short-term sentiment analysis, investors may also monitor the extent to which stocks are shorted.

If more than 20% of a stock’s float (available shares) are shorted, then even a small rise in its price could actually trigger a powerful short squeeze, propelling the stock much higher.

At this point, over 27% of CRON stock is shorted. And it would take about ten days for those shorting the shares to cover i.e. close out, their short positions. Therefore, Cronos Group stock may soon become a candidate for a short squeeze, especially if the industry, in general, is rallying.

However, I do not think any potential rally by CRON will last long. Cronos Group stock is likely to move between $6 and $7 in the coming weeks.

The Bottom Line on CRON Stock

Given the high inventory at Canadian provinces and decreasing prices across the country, it would be hard to argue for a short-term catalyst that could give a boost to share prices of cannabis companies, including Cronos Group.

In other words, investors are not likely to rush in to invest in publicly-traded cannabis companies anymore as questions about the strength of the Canadian legal marijuana market dominate.

In its quarterly results, Cronos Group regularly highlights its focus on technology, innovation, and global opportunities. But these markets probably won’t generate any substantial sales in the near-term. In short, at this point, the company offers no clear way to sustained profitability.

Therefore I regard Cronos Group stock as a quite risky investment. Despite its relatively large market cap, CRON stock remains a small participant within the Canadian legal cannabis market. Shareholders should be ready to endure a period of slow growth by CRON.

As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

Tezcan Gecgil, PhD, began contributing to InvestorPlace in 2018. She brings over 20 years of experience in the U.S. and U.K. and has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Publicly, she has contributed to investing.com and the U.K. website of The Motley Fool.


Article printed from InvestorPlace Media, https://investorplace.com/2019/11/contrarian-investors-hold-off-cron-stock/.

©2024 InvestorPlace Media, LLC