Pot stocks have been killed over the past six months. From early May to early November, each one of the major big four pot stocks — Canopy Growth (NYSE:CGC), Cronos (NASDAQ:CRON), Aurora Cannabis (NYSE:ACB), and Tilray (NASDAQ:TLRY) — have shed at least 50% of their value. CRON stock, even with a still-very-large 50% drop since early May, did the best of the bunch.
It’s like a bad joke: the good news is Cronos stock beat its peers; the bad news is half its value was lost. (cue rimshot …)
However, it’s actually a bit of both good news and bad. In the big picture, CRON stock will rebound from this recent sell-off. But it won’t rebound now, or anytime soon. Instead, Cronos stock finds itself in a classic case of “near-term pain, long-term gain”.
The investment implication is simple. Stay away from CRON stock for now. Once cannabis market fundamentals improve, buy CRON stock.
Three Factors in Cronos Stock’s Favor
Cronos stock will rebound, eventually, for three big reasons.
One, long-term cannabis market fundamentals are healthy, and imply that this will be a multi-hundred billion dollar industry one day. Decades of data shows that marijuana consumption is on the up and up, while alcohol consumption is on the decline, to the point where consumers like to smoke cannabis almost as much as they like to drink alcohol today. Thus, once fully legal, there is ample demand to support a global cannabis market equivalent in size to the global alcoholic beverage market, which is a multi-hundred billion dollar industry.
Two, Cronos has advantageous competitive positioning to grow in the multi-hundred billion dollar cannabis market. The grower scored the crown jewel of investors when tobacco giant Altria (NYSE:MO) agreed to pour $1.8 billion into the cannabis start-up. Altria is an $85 billion tobacco giant with almost limitless resources — and Cronos has them in their back pocket. No other cannabis company, save Canopy, has this luxury, and Canopy’s partner — Constellation Brands (NYSE:STZ) — is about half the size of Altria. When it comes ability to invest in the multi-hundred billion dollar global cannabis market, Cronos is second to none, meaning that this company has tremendous profit growth potential over the next decade.
Three, CRON stock is cheaper than peers. On an enterprise value basis, CRON stock trades at 3.3 times consensus fiscal 2021 revenue estimates, according to YCharts. That’s well below’s Canopy’s 3.7x 2021 EV-to-sales multiples, and even further below Tilray’s 4.4x 2021 EV-to-sales multiple. Indeed, it’s the lowest 2021 EV-to-sales multiples among the Big 4 pot stocks. This relative undervaluation should provide ample firepower for CRON stock to power higher once macro cannabis sentiment improves.
Given these three factors, it is very likely that CRON stock will eventually rebound from today’s depressed levels, and shoot materially higher in the long run.
Near-Term Pain Is Here To Stay, For Now
Although Cronos stock will rebound from today’s depressed levels in the long run, the reality is that it won’t rebound now, or anytime soon. Instead, shaky near-term cannabis market fundamentals will keep pot stocks broadly depressed for the foreseeable future.
The Canadian cannabis industry is a mess right now. There are supply issues, caused by choppy, inconsistent, clunky, and slow legislation. This has hampered both the number of legal cannabis store openings in Canada, and the volume of cannabis for-sale in the legal market. There are demand issues, because constrained supply has led to higher prices, and those higher prices have kept consumers largely in the black market. Simultaneous supply and demand issues have created significant revenue and margin headwinds for legal cannabis companies. The result? Reduced revenue growth rates, and margin erosion.
Worse yet, the outlook is for these dynamics to persist. There aren’t any signs out there that legislation will start to move more quickly. Until it does, the legal market will lag the black market in terms of supply. That will lead to continued demand headwinds, which will result in lower revenue growth rates and lower margins.
So long as all this remains true, it will be tough for all pot stocks — CRON stock included — to bounce back. As such, before buying the dip in Cronos, investors should wait for the near-term cannabis market fundamentals to improve, starting with hastened and more streamlined legislation.
Bottom Line on CRON Stock
I like CRON stock long term. But, I don’t like it here and now. Instead, the best thing to do here and now is to monitor the situation from the sidelines, and buy CRON stock on this dip only once broader cannabis market fundamentals improve. Until then, the sidelines are the best (and safest) place to hangout.
As of this writing, Luke Lango was long CGC.