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Why Cronos Group Shares Are Plunging Today

By Keith Speights - Aug 30, 2018 at 4:33PM

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A critical report from a noted short-seller causes the marijuana stock to give up a lot of its recent gains.

What happened

Shares of Cronos Group (CRON 3.93%) were down 29.8% as of 3:30 p.m. EDT on Thursday. The big decline came after noted short-seller Andrew Left's Citron Research warned about "hype vs. reality" with the marijuana stock. 

Citron Research published an online report titled Cronos: The Dark Side of the Cannabis Space. It alleged that Cronos Group's management has been "deceiving the investing public" by not disclosing the size of its supply agreements with Canadian provinces.

Businessman looking at falling line chart

Image source: Getty Images.

The Citron report also criticized Cronos on several other fronts. It stated that Cronos underperformed all of its major rivals in revenue in its last quarter and spent little on research and development (R&D). Citron also pointed out the company's contamination issues in the past and raised doubts about Cronos' international strategy.

Because of these issues, Citron expressed skepticism that British alcoholic beverage maker Diageo (DEO 0.58%) would consider Cronos Group as a cannabis partner. Cronos stock has soared recently in part due to investors' anticipation that the company would be on Diageo's short list of prospective partners. 

So what

Investors need to keep today's drop in perspective. Cronos Group stock is still up more than 40% in just the past month despite the fallout from the Citron Research report.

There is some truth to the points raised by Citron. Unlike several of its peers, Cronos Group has not disclosed the size of its supply agreements with Canadian provinces. However, referring to this omission as "deceiving the investing public" is a stretch. 

Cronos did have some contamination issues with its cannabis products in 2017. But so did one other Canadian marijuana grower. The company appears to have resolved those issues.

Is Cronos Group's revenue less than several other Canadian marijuana growers? Yep. But it's also increasing it faster than many of them, too. And while the company isn't investing much in R&D, that's not exactly a major problem at this point.

There are two issues raised by Citron Research that I think are more relevant to Cronos Group's future. Questions about its international strategy and its likelihood of being selected as a partner by Diageo or another major company are valid, in my opinion. 

Cronos claims a major partnership with German pharmaceutical distributor Pohl-Boskamp and a joint venture in Australia, and it recently teamed up with Delfarma to enter the medical cannabis market in Poland. Despite all of these efforts, I do think it's possible that Cronos could get left behind to some extent in the global cannabis market.

As for a Diageo partnership, my hunch is that there are candidates higher on the list for the big beverage company. With much of Cronos Group's recent gains fueled by speculation that it could be picked by Diageo, a sell-off is probably warranted.

Now what

Citron Research's track record is mixed at best. Investors shouldn't panic just because Citron raised issues about Cronos, none of which are secrets to anyone who follows the marijuana grower.

However, questioning whether or not a stock has shot up too much is a good thing to do. Cronos Group's market cap hinges on an extraordinary level of growth. It will no doubt see tremendous growth when Canada's recreational market opens in October. I'm not sure, though, that the growth will be enough to justify the stock's current valuation.

I don't think Cronos is, as Citron alleges, deceiving investors. But investors shouldn't deceive themselves that the path forward for Cronos Group will be easy and that the momentum from the last month is sustainable. 

Keith Speights has no position in any of the stocks mentioned. The Motley Fool recommends Diageo. The Motley Fool has a disclosure policy.

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Cronos Group Stock Quote
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$3.17 (3.93%) $0.12
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