The marijuana industry certainly lived up to the hype in 2018. After years of promises that recreational cannabis would be legalized from Prime Minister Justin Trudeau, Canada made his vision a reality. As the first industrialized country to give the green light to adult-use pot, Canada opens its doors to what could be billions of dollars in added annual sales within the next two or three years.
Of course, quite a few marijuana stock investors didn't share in the weed industry's game-changing year. In fact, 10 pot stocks saw at least half of their value disappear in 2018. One of the few pot stocks to have bucked that trend was Ontario-based Cronos Group (CRON 2.40%), which gained 34% last year.
The big question is: Can Cronos Group continue this momentum into the new year? With valid arguments to be made on both sides of the aisle, let's take a closer look.
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Cronos Group could again be a top performer
Arguably one of the most followed and liked pot stocks on major U.S. exchanges, Cronos Group brings a number of catalysts to the table that investors can stand behind.
Last year, nothing stood out more than the December-announced deal that Marlboro-cigarette maker Altria (MO +0.81%) would be investing $1.8 billion into Cronos Group. Assuming regulatory approval of the equity investment, Altria is set to become a 45% stakeholder in Cronos, with the option of increasing this stake to 55%, if the warrants it's also receiving are fully exercised.
This equity investment has multiple purposes. For Altria, it gives the company access to the fast-paced cannabis space at a time when tobacco cigarette volumes in the U.S. are in precipitous decline. Although Altria has managed to grow its business via price hikes, it's really lacked the innovation needed to take the next step. Cronos Group's products and partnerships in vape products could be that stepping stone. Not to mention, Altria's 45% stake demonstrates a larger belief that the marijuana industry is legitimate and here to stay.
Meanwhile, Cronos Group gains a partner with an excellent track record of marketing new products and expanding into new territories. Plus, it doesn't hurt that Altria has a lot of cash on hand to facilitate research. Assuming Canada's Parliament approves new consumption options in 2019, such as edibles and vapes, Altria and its new partner will be in great shape.
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Investors should also be excited about the projected mid-year completion of the joint venture Cronos GrowCo facility. Back in July, Cronos and a group of investors agreed to construct an 850,000-square-foot facility capable of 70,000 kilograms of annual output when at full capacity. Prior to announcing this facility, Cronos was primarily reliant on its Peace Naturals grow site and a small pittance of annual output from Original BC. Following this deal, Cronos puts itself on track for more than 100,000 kilograms in peak annual yield, placing it among the largest producers in Canada. As this production comes online, investors will be eager to see how Cronos steps up to meet domestic demand.
And let's not forget about the company's efforts to diversify its product portfolio away from dried cannabis. In early September, Cronos inked a deal with Ginkgo Bioworks to utilize Ginkgo's platform to develop yeast strains capable of producing cannabinoids (some of them rare) at commercial scale. This represents a high-margin venture that'll help protect Cronos Group in case the per-gram price of dried cannabis flower falls in the future.
Plenty of risk with far too little reward
Then again, there are a number of reasons why investors might be best served remaining on the sidelines in 2019.
Just as the biggest reason to buy into the Cronos growth story was its deal with Altria, one of the top reasons to stay away is also its deal with Altria. Don't get me wrong: There's a lot to be said about Cronos in that it was able to lure a brand-name tobacco company to invest $1.8 billion. The question is, where does the additional value come for investors? Altria paid $1.8 billion for 45% of a company that may only yield between 110,000 and 120,000 kilograms of marijuana at peak capacity. By comparison, you can get the same exact peak yield from OrganiGram Holdings for less than $600 million for the entire company.
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To build on this point, Cronos Group is well behind many of its large peers in terms of capacity expansion and branding. The company probably won't have a shot at topping 70,000 kilograms in run-rate production until sometime in 2020 -- Aurora Cannabis was already there as of November 2018. It also, arguably, doesn't have the same brand recognition as other billion-dollar-market-cap growers.
Another reason to avoid Cronos Group is the company's bottom line. With Canada legalizing recreational weed, a shift occurred in how Wall Street and investors analyze pot stocks. Whereas previously it was perfectly fine for marijuana stocks to rally on simple promises of profitability, operating results actually matter now. Because Cronos Group is going to be spending a lot of money on capacity expansion, marketing, brand building, research and development, international expansion, and possibly acquisitions, there's little chance of a meaningful profit -- and an even smaller possibility of an operating profit.
Currently, the company is staring down a forward price-to-earnings ratio of an unsightly 263! That's enough to make any would-be investor turn around and head in the other direction.
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The verdict?
With the cannabis industry set to really blossom in 2019, what's an investor to do?
With a mountain of cash presumably awaiting Cronos Group, financing is no longer a concern. That's a good thing, and it should take any worries of significant downside out of the equation. Also, the company's joint venture construction remaining on track has been key.
But this ultimately comes down to whether or not Cronos' share price can expand from here – and I'm not certain it can. Once the deal is complete, Cronos could be valued at close to $4.5 billion to $5 billion, yet be producing as much cannabis as companies with market caps of $600 million to $1 billion. Worse yet, it still has work to do on the branding front and is no guarantee to be profitable in 2019 or 2020. Wall Street looks to have placed way too much faith in the Altria deal, so I'd suggest avoiding Cronos Group in 2019.
Check out the latest Cronos Group earnings call transcript.
