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This Marijuana Stock Pioneer Lands Its Biggest Supply Deal to Date

By Sean Williams - Aug 15, 2018 at 8:21AM

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How does 20,000 kilograms a year over the next five years sound?

In just two months and two days, the wait will be over. On Oct. 17, recreational marijuana will officially go on sale throughout Canada.

What does legal weed mean to the marijuana industry? Oh, you know, just somewhere in the neighborhood of $5 billion in annual sales added atop the couple hundred million dollars it had been bringing in via medical pot sales and exports. To say it's a big deal would still be an understatement, since this influx of demand and revenue is expected to make most marijuana stocks profitable.

A person holding cannabis leaves in their cupped hands.

Image source: Getty Images.

With supply and demand uncertainty, long-term production deals come into focus

But the launch of legal weed in our neighbor to the north is unlikely to go off without a hitch. Remember, no industrialized country has ever given the green light to recreational pot before, so the supply-and-demand outlook remains nothing more than guesswork at this point.

Projections would appear to suggest an initial shortage, which would work in favor of growers via strong per-gram pricing. This expected shortage is a direct result of growers having waited until the passage of the Cannabis Act seemed certain before spending tens or hundreds of millions of dollars on capacity expansion.

However, once this production comes on line fully in 2019 and 2020, supply will quickly catapult higher. In fact, it's possible that the domestic market could be overwhelmed by more than 1.5 million kilograms of oversupply that'll need to be shipped to overseas markets where medical marijuana has been legalized. It's this threat of oversupply, and the possible decline in the per-gram dried cannabis price, that makes landing long-term supply contracts so important.

Jars filled with trimmed cannabis buds lining the counter.

Image source: Getty Images.

This trailblazing pot stock just landed a huge deal

Last week, on Aug. 9, marijuana stock pioneer Cronos Group (CRON -1.61%), which became the very first pot stock to uplist from the over-the-counter exchange to a reputable U.S. exchange (the Nasdaq) at the end of February, announced its largest supply deal to date.

According to a press release from Cronos Group, it's entered a five-year deal with privately owned Cura Select Canada to supply a minimum of 20,000 kilograms per year via a take-or-pay supply agreement. Cura plans to build a state-of-the-art extraction facility on a parcel of land owned by Original BC (a wholly owned subsidiary of Cronos Group), and use the strains produced by Cronos Group to develop cannabis oil and CBD-focused oil products.

As a refresher, oils have a considerably higher price point and better margin than dried cannabis. Therefore, Cura's British Columbia cannabis oil hub could become its prime moneymaker in domestic and international markets. According to BDS Analytics, Cura's Select Oil and Select CBD products are the best-selling brands on the West Coast of the United States at the moment. 

This deal also represents a notable portion of Cronos Group's annual output. Among its core assets, Cronos Group looks to be on pace for around 70,000 kilograms of annual production, in my best estimate. A recently announced joint venture with a group of investors (known as Cronos GrowCo) should add another 70,000 kilograms at peak capacity. Added together, this deal with Cura could account for around 15% or more of peak annual production. That's 20,000 kilograms (or more) Cronos doesn't have to find a buyer for each year, for at least the next five years.

A hand reaching for a neat stack of hundred dollar bills in a mouse trap.

Image source: Getty Images.

A lot of unanswered questions

With Cronos landing such a large supply deal, investors are probably wondering if it might now be worth a closer look. My suggestion? Not at the moment.

The biggest red flag for Cronos Group is the company's valuation. While I'm well aware that practically all marijuana stocks have nosebleed valuations, there are circumstances surrounding Cronos Group's forward price-to-earnings ratio of 71 that makes this stock highly avoidable.

For starters, it's going to be a while before the company brings the bulk of its production on line. Though a practical doubling in peak annual capacity was announced last month, you simply can't snap your fingers and deliver 70,000 kilograms of production annually. With Cronos unlikely to be on a 100,000-plus annual kilogram pace until sometime well into 2020, I worry about how costs will erode its bottom line the short term, as well as how it could miss out on other lucrative supply agreements due to its delayed expansion.

While we're on the topic of supply agreements, let's not forget that Cronos Group's role with Cura is to supply cannabis strains -- and these strains could be subject to commoditization as supply grows. Or, in plainer English, marijuana prices could plummet by 2020 and beyond. We've already observed the per-gram price of dried cannabis collapse in Colorado, Washington, and Oregon, and it's begun declining in California less eight months after the product went on sale in dispensaries. This suggests that Cronos Group's margins could be especially challenged, relative to its peers.

Clearly, Cronos Group is making its case to be a major player in Canada. But at this point in time, it doesn't offer anything in particular that resembles an enticing value proposition.

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