Cronos (NASDAQ:CRON) stock dropped sharply in early August after the Canadian cannabis company reported second-quarter numbers which, while strong on the revenue front, were weak on the margin and profit fronts, and broadly underscored the bear thesis that profits are a long way out for Cronos.
That may be true. Cronos may not push into the black for at least another few years.
But that doesn’t mean CRON stock is a bad buy here.
Rather, there’s a compelling argument for why Cronos stock could essentially double over the next few months, on the back of rebounding demand, favorable legislation progress, improving margins and narrowing losses.
Strong Upside Drivers on the Horizon
To-date, Cronos has been crushed by three major headwinds:
- Sluggish demand in its core Canadian market thanks to tight restrictions on the legal cannabis industry in that country.
- A lack of tangible progress on nationwide marijuana legalization in the U.S.
- Falling cannabis commodity prices putting pressure on gross margins due to the company’s asset-light model which utilizes contract manufacturers.
Those headwinds led to sluggish revenue growth, eroding margins, widening losses and stock price declines at Cronos.
But all three of these headwinds could reverse course in the back half of 2020.
Specifically, Canada continues to ease restrictions on things like cannabis retail store openings and taxes, two moves which should couple with a post-pandemic rebound in consumer spending to spark strong legal cannabis sales growth in the third and fourth quarters of 2020.
At the same time, there’s a chance for a “blue wave” in the U.S. in November, wherein the Democrats keeps the House while taking the Senate and White House. Such a move would presumably lay the foundation for nationwide legalization of cannabis in 2021, given that the liberal platform is more supportive of cannabis adoption and legalization than the conservative platform.
Not to mention, rebounding demand in Canada – plus a potential new surge in demand in cannabis if the U.S. gets legalized – should normalize out the supply-demand imbalance in cannabis markets. Commodity prices will rebound. Cronos’ margins will rebound, too.
Net net, over the next six months, you could see Cronos’ sluggish revenue growth accelerate, depressed margins rebound and widening losses narrow. If all that happens, then today’s beaten up CGC stock price will soar.
Cronos Stock Is Undervalued
By my numbers, nearly 100% upside in CGC stock is possible over the next six months.
Here are those numbers:
- Rising consumer demand for alternative recreational drugs — like cannabis — coupled with supportive legislation will power huge growth in the global cannabis market over the next five to 10 years, leading to this market measuring $40 billion by 2024, and potentially $60 billion by 2030.
- Cronos leverages its investment from Altria (NYSE:MO) and the $1.3 billion in cash and short-term investments sitting on its balance sheet to strategically invest in long-term growth opportunities, enabling the company to grow 2% to 3% market share at scale.
- Economies of scale and a more favorable commodity pricing dynamics push gross margins up towards 50%, roughly where they sit in the alcoholic beverage industry today.
Assuming those things happen, my modeling suggests that Cronos has a visible opportunity to net $1 in earnings per share by 2030.
Based on a 20x forward earnings multiple, that implies a 2029 price target for CRON stock of $20. Discounted back by 8.5% per year, that implies a 2020 price target for CRON stock of nearly $10.
That’s almost 100% above the current CRON stock price.
Bottom Line on CRON Stock
I understand Cronos has had its troubles. I also understand that the company’s second-quarter earnings report didn’t do much to fix those troubles.
But the company has $1.3 billion in cash and investments sitting on its balance, is supported by the biggest tobacco company in the world, hasn’t been focused on near-term results and has some huge long-term growth opportunities ahead of it.
Thus, I think patience will be rewarded here.
In the long term, CRON stock is going higher. If you can afford to wait it out, I say buy the dip here and do exactly that. Wait it out.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the best stock pickers in the world by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.