Cronos Group (CRON 0.41%) is one of a slate of cannabis companies positioning itself to benefit from the growing use of marijuana globally, and this week its management updated investors on the company's latest quarterly performance and its plans for the future. With sales growing triple digits and marijuana production capacity expected to skyrocket in 2019, is Cronos Group's stock a buy?
What's going on now
There's a lot of momentum to legalize marijuana in the U.S., but it remains illegal at the federal level, so the biggest marijuana companies are focusing their attention on Canada, where a successful medical marijuana market has been operating nationwide for years and a nationwide recreational market opened for business in October.
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According to Cronos Group's management, a bump up in demand ahead of Canada's adult-use market opening on Oct. 17 helped lift its sales in the third quarter. Specifically, sales increased 186% to $3.8 million last quarter from $1.3 million in Q3 2017 as kilograms sold increased 213% year over year to 514 kilograms. The jump in kilograms sold more than offset a retreat in average selling prices per gram to $7 from $8.50 in December 2017.
Despite its increasing revenue, the company still lost money last quarter because its expenses grew even more quickly than its sales. General and administrative expenses more than tripled from last year to $4.8 million, and total operating expenses were $6.97 million last quarter, or 185% of sales. As a result, Cronos Group lost $7.3 million, or $0.04 per share, in the quarter.
Ramping up production
The recreational market opportunity dwarfs the opportunity associated with the medical marijuana market in Canada, so expectations for significant sales growth at Cronos Group in the coming year are high. The adult-use market's first few weeks have been mired by supply shortages, though, so delivering that sales growth is going to depend on the progress the company makes in boosting its marijuana production.
Currently, Cronos Group says its annualized production capacity is only about 6,650 kilograms. However, the company raised $146 million, net of fees, earlier this year, and that money is financing expansion projects that are anticipated to increase annual capacity to 117,000 kilograms per year in the future.
Cronos Group should begin seeing a benefit from its expansion efforts soon, because it recently completed construction of a fourth building ("building 4") for its Peace Naturals brand. Building 4 is already cultivating cannabis, and once it's fully up to speed in Q2 2019, it's expected to add 33,500 kilograms of capacity, which will increase Cronos Group's overall production to 40,150 kilograms per year.
Even more capacity should become available in the second half of 2019 because that's when a new greenhouse for its joint venture, Cronos GrowCo, is expected to be finished. A 50/50 collaboration between Cronos Group and a leading greenhouse operator, Cronos GrowCo has already begun construction on an 850,000-square-foot facility that will add 70,000 kilograms of production capacity when it's finished.
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Building its brands
In addition to Peace Naturals, a medical marijuana brand, Cronos Group's wholly owned subsidiary, OGBC, has launched two new brands -- Cove and Spinach -- that target recreational customers in Ontario, British Columbia, Nova Scotia, and Prince Edward Island.
Cove is being positioned as a hand-trimmed, premium product that uses the best marijuana flowers from each harvest, while Spinach is being positioned as a mainstream brand for people who "don't take life too seriously." Cronos hopes Spinach's "Farm-to-Bowl" products and a "playful" marketing message will resonate with consumers and that Cove's premium products will give it pricing power.
Initially, Cronos is selling rolled products, dried flower, and cannabis oils for the adult-use market, but plans to sell value-added marijuana products, such as beverages and edibles, throughout Canada as soon as regulators allow it. The exact timing of a decision on edibles and beverages isn't certain, but they're not expected to be available at least until Oct. 17, 2019.
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Is Cronos Group's stock a buy?
The company's sales are growing, but Cronos Group is tiny compared with Canada's biggest cannabis companies. For example, Aurora Cannabis' peak marijuana production is expected to be over 500,000 kilograms and Aurora's pro forma revenue was over $35 million last quarter.
Cronos Group's 56% gross margin is also shy of competitors, including Aurora Cannabis, which just reported a gross margin of 70% in its most recent quarter. Cronos Group's margin may improve if pricing for its premium products boosts average net selling prices and its expansion efforts result in lower-cost production, but that remains to be seen.
Furthermore, Cronos Group's valuation is among the highest of the most widely followed cannabis companies. Despite annualized sales of only $15.2 million, it boasts a $1.5 billion market cap and its shares trade at 214 times trailing 12-month revenue.
Overall, I think Cronos Group has an opportunity to deliver significant sales growth in the coming year, but I think a lot of that growth is already priced into its shares. Therefore, marijuana stock investors might want to consider other alternatives for now.
