Even after a more than 67% decline, Cronos (NASDAQ:CRON) stock remains overvalued. And among the frothy valuations of its pot stock peers, Cronos Group stock sells at a premium. While the more established cannabis stocks trade at enterprise value/sales (EV/Sales) ratios of 30 and below, Cronos trades at an EV/Sales ratio well over 50.
High growth projections drive this valuation for CRON stock. Analyst consensus estimates revenue to grow from $39.2 million in year ending December 2019 to $145.9 million in year ending 2020. But this sales growth is largely due to Crono’s small size relative to the bigger pot names. Once Cronos reaches sales on par with Aurora Cannabis (NYSE:ACB) and Canopy Growth (NYSE:CGC), this growth will slow.
But with the backing of Altria Group (NYSE:MO), and high short interest, betting against Cronos stock may not be the best move. With this in mind, here is why you should stay on the sidelines with CRON stock.
Future Prospects for CRON Stock
Cronos stock looks overvalued, but some analysts believe shares have runway. Stifel analyst Andrew Carter estimates the company can become cash-flow positive by 2021. This seems questionable given the long road to profitability for other pot stocks. Carter believes the launch of vapes, along with CBD sales in America, will drive revenue growth. Thanks to Altria’s backing, the company has the cash to survive as it scales to profitability.
Cronos recently announced a deal to acquire CBD startup Lord Jones for $300 million. On the surface, this deal looks expensive. The company is paying 75-150 times Lord Jones’s 2018 sales. Also, Cronos CEO and another board member are principals in a fund that invested in Lord Jones. They stand to collect a large part of the sale proceeds. But it seems Altria was okay with this deal, as both Cronos insiders recused themselves from the negotiations.
This recent deal gives us an idea of Altria’s endgame for Cronos. Altria is using the tobacco company playbook to build a brand-focused company. While the larger pot names focus on expanding production facilities, Cronos is moving to a global supply chain model. This model does include some company-owned production facilities. But the focus is on acquiring raw marijuana product from third-party suppliers.
This is like how the tobacco industry works. Altria Group doesn’t own tobacco fields. Instead, it acquires raw tobacco, and processes it into branded products (cigarettes, cigars, smokeless tobacco, etc). This strategy could be the smarter way to build a scalable marijuana-focused company.
But can investors in CRON stock win along with Altria? Probably not. Altria has the clear advantage over the average Cronos stock investor.
Altria Is in the Driver’s Seat
On Oct. 31, InvestorPlace contributor Mark Hake made strong points about Altria’s stranglehold on Cronos. After making their $1.8 billion investment in 2018, Altria is clearly in the driver’s seat. While shares are below the strike price of Altria’s warrants, they have every incentive for the Cronos Group stock price to go lower. If Cronos burns through its current cash hoard, they will need to go back to Altria for more money.
Altria gains a larger share of Cronos stock at lower prices. Like Constellation Brands’ (NYSE:STZ) de-facto takeover of Canopy Growth, Altria has a plan. While this may allow the tobacco giant to gain a toehold into the pot space at a lower price, Cronos shareholders are going to lose in the long run.
Dilution risk with pot names remains a high risk. Especially with names like CRON stock. A deep-pocketed partner is a double-edged sword.
Stay on the Sidelines with Cronos Stock
CRON stock sells at a high valuation. But this premium to peers may not be irrational. While competitors may struggle with capital needs, CRON has the cash to survive a pot stock maelstrom. Yet, this means Altria is in the driver’s seat.
Cronos is pursuing a unique strategy to rule the pot space. Their focus isn’t on production, but on building a portfolio of brands. This could pay off big, but it is unclear when profitability will arrive. In the meantime, Altria can continue pumping money into the company. Additional dilutive equity sales to Altria will drive the CRON stock price lower.
This makes it tough for average investors to win with Cronos stock. On the other hand, high-short interest may mean its too late to go short CRON. The company’s shares could rally in a short squeeze scenario.
So what’s your play with Cronos stock? Avoid!
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities