Canadian cannabis producer Cronos (NASDAQ:CRON) reported third-quarter 2019 numbers in early November that — while strong on the revenue and volume fronts — showed that this company is still struggling tremendously with profitability. CRON stock traded narrowly higher on the news. But, the 2% post-earnings bump in Cronos stock is nothing compared to the 50% beating shares have taken over the past six months.
Taking a step back, there are two realities here for CRON stock.
First, Cronos increasingly appears positioned to be a survivor in this market, and CRON stock consequently appears materially undervalued relative to the company’s long-term profit growth prospects.
Second, investors won’t buy into the first reality — and CRON stock won’t rebound — until the company figures out its profitability issues, margins head higher and presently wide losses start narrowing.
The investment implication? Don’t buy the dip in CRON stock just yet. This stock will remain weaker for longer. But, keep the stock on your radar. Once the company does figure out its profitability issues, that could spark a huge rebound that you don’t want to miss.
Cronos Stock Is Undervalued
When it comes to cannabis stocks, my investment thesis is very simple.
Current consumption trends imply that the cannabis market will be huge one day — like alcoholic beverage and tobacco market huge. Each of those markets birthed multiple $20 billion-plus companies. The cannabis market will do the same. But, before it does, it will kill a bunch of companies. As the market matures and grows, it will consolidate around a few large players, who will reap all the rewards while everyone else falls by the wayside. That’s just how markets work.
The implication is simple. About 95% of pot stocks today won’t be around in a decade. As for the other 5%, they will turn into $20 billion-plus companies.
It has become increasingly clear that Cronos belongs in the second, smaller group of long-term winners for various reasons.
First, and most importantly, Cronos has landed a multi-billion dollar partnership with tobacco giant Altria (NYSE:MO). This gives Cronos unparalleled ability to invest in the cannabis market and tons of cash to buffer against wide losses today. Second, Cronos has been leveraging this partnership to drive huge volume and revenue gains. Volumes were up more than 500% year-over-year last quarter, while revenues were up nearly 240% year-over-year. Third, the company has also been leveraging its resources to lay the foundation for big growth in the long run. This includes acquiring new brands to broaden and diversify the product portfolio, expanding operations geographically to tap into new markets and building out capacity to further increase supply volumes.
It looks like Cronos will survive cannabis market consolidation, and ultimately, turn into an important player in the global cannabis market. Assuming this, CRON stock looks undervalued today.
Shares Won’t Rebound Yet
Although CRON stock looks undervalued today, it’s unlikely that shares will stage a huge comeback anytime soon.
Why? Because investors won’t buy into this idea that Cronos is a long-term winner until it becomes clear that the company can be profitable at scale.
Right now, the profit trends don’t look good. In the third quarter, gross margins dropped 14 points year-over-year and 12 points quarter-over-quarter to their lowest level of 2019. Long story short, legal-related expenses are making it tough for legal supply to compete with black market supply, so in order to move product, the legal channel is being forced to cut prices.
So long as this dynamic persists, investors won’t buy into the CRON stock rebound.
When will this discounting problem get fixed? No one really knows. A lot of it depends on how legislation adapts to the current situation. Will black market penalties get more severe? Will legal market taxes be reduced?
There is a clear lack of visibility as to exactly when Cronos’ profit trends will improve. So long as this is true, CRON stock will remain weak.
Bottom Line on CRON Stock
There will come a time when buying the dip in CRON stock is the right move. Long term, this stock is going way higher as the cannabis market goes global.
But, that time is not now. Instead, for the time being, Cronos stock will remain weak, mostly because the company’s profit trends remain weak, and there is a lack of visibility as to when they will improve.
Until they do improve, CRON stock won’t rebound in a big way.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.