Is today a good time to buy Cronos Group (NASDAQ:CRON) stock? The “Cannabisphere” is a hot mess, to say the least. But, backed by tobacco giant Altria Group (NYSE:MO), Cronos stock may have the cash and support to survive the maelstrom. As rivals scramble to sell assets and raise capital, this major pot company could be a buyer in a seller’s market.
Yet, valuation may be a reason not to buy at today’s prices. Thanks to its strong balance sheet, Cronos trades at a premium. It’s a similar situation to what we see at Canopy Growth (NYSE:CGC). The underlying industry may be in turmoil. But thanks to a cash-rich balance sheet, and a deep-pocketed strategic partner, shares continue to be valued higher than, say, Aurora Cannabis (NYSE:ACB) or Hexo (NYSE:HEXO).
Nevertheless, paying a premium could be a rational move. Cronos stock could soar higher in the next few years. Why? Their unique strategy. Focusing on the marketing and sales aspect — as opposed to production — Cronos could have the edge as integrated pot producers shut down or sell off facilities.
With this in mind, let’s dive in and see what’s the verdict on Cronos shares.
Why Cronos Stock Could Rebound
It’s safe to say that Canadian-based pot stocks face many issues. Oversupply and regulatory headwinds persist. Add the long-shot odds of U.S. federal-level legalization. Put it all together, and it doesn’t seem smart to buy pot stocks today.
But Cronos stock could be the exception. At least according to MKM Partners’ Bill Kirk. The analyst recently upgraded shares to Buy from Hold. The reason? Namely, the Altria connection. Thanks to the tobacco giant’s existing relationships with convenience store chains, Cronos has a big infrastructure edge if and when recreational pot use is legal nationwide in the United States.
Also, Kirk is bullish on Cronos thanks to its large cash position. Out of a $1.9 billion market capitalization (based on the March 11 closing price of $5.41 per share), the company has $1.5 billion in its coffers.
Yes, the company hemorrhages cash like its peers. But, thanks to an asset-light approach, cash burn is lower than that of Canopy or Aurora. With Cronos’ business model, you can see the similarities between it and its partner, Altria.
Most marijuana companies have tried to handle all aspects of pot production. From operating growing facilities to selling it in retail locations. Cronos is using the tobacco industry playbook. Altria and the other U.S.-based tobacco companies don’t own tobacco farms. They buy it wholesale, process it into cigarettes and other tobacco products, and sell it via third-party retailers at a high markup. The same high-margin business model could be applied to the recreational pot space.
Kirk makes a compelling case for Cronos as one of the best pot stocks. Yet, that doesn’t make shares a buy at today’s prices. Especially with valuation and other red flags being key downside risks.
Watch Out for Valuation and Other Red Flags
Despite shares taking a beating in recent months, Cronos stock remains overvalued. Shares trade at an enterprise value/sales ratio of 17. That’s higher than even richly priced Canopy Growth’s EV/Sales ratio of 12.5.
Looking at the other pot names, the valuation discrepancy is even wider. Tilray (NASDAQ:TLRY) has an EV/Sales ratio of 7, while Aurora and Hexo are each under 6.
You could argue the Crono’s strong balance sheet warrants a premium. Yet, there other factors at play that should give investors pause. As InvestorPlace’s Wayne Duggan wrote March 5, Cronos is delaying earnings due to an audit of its finances. In addition, the company expects to take a massive write-down on inventory. If these risks turn out worse than anticipated, shares could dive even lower.
With this in mind, why buy now? These risk factors, along with a stock market trending lower, make near-term downside more likely than upside.
Wait-And-See May be the Best Approach
Bottom line on Cronos stock: consider it a buy … at a lower price. While shares have fallen more than 75% from their 52-week high, the stock is not exactly cheap. You could argue that the company could grow into its valuation. But, with the ongoing audit and weak fundamentals in the Canadian pot market, it’s hard to put much faith in future results.
On the other hand, Cronos’ underlying business model could be a solid path to future profitability. While peers try to handle all aspects of pot production, Cronos is smartly employing the tobacco industry playbook. This could help the company evolve into a cash-cow business.
Add in the Altria connection, and Cronos stock could be a big winner. But that’s over a long time horizon.
Even with changes in the NFL marijuana policy likely to stir up sentiment this week, the best play is to wait for shares to reach a more reasonable valuation.
Thomas Niel, contributor to InvestorPlace, has been writing single-stock analysis for web-based publications since 2016. As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.