Canadian pot titans Aurora Cannabis (ACB 17.87%) (ACB 18.15%) and Cronos Group (CRON 4.66%) have both seen their shares ring in the new year with absolutely astounding gains. Aurora's stock, for instance, has shot up a whopping 59% since the start of 2019, whereas Cronos' shares have gained a staggering 109% during just the first five weeks of the new year.
What's behind this blistering growth? Unfortunately, the underlying reason isn't readily apparent. Aurora, for its part, did acquire privately held Whistler Medical Marijuana Corporation in an all stock transaction, as well as raise an additional $345 million via a senior note offering in January. But neither of these strategic moves justifies a $2.9 billion bump in market capitalization.
Image source: Getty Images.
Cronos, on the other hand, has basically maintained radio silence during the first few weeks of 2019. Now, the pot company's partner Altria (MO 0.70%) did provide investors with a rather upbeat outlook on the duo's prospects in the high-value cannabis space during its fourth-quarter conference call. But even that upbeat assessment wasn't exactly groundbreaking news.
So, given the lack of a material catalyst behind either of these enormous moves northwards, it's arguably the perfect time to consider if investors should start to take profits in these two white-hot pot stocks. Let's dig deeper to find out.
Aurora's value proposition
Aurora is a serial acquirer. Over the last two-plus years, the company has gobbled up over 16 of its direct and indirect competitors to build out a sprawling cannabis business that touches almost every corner of the industry.
Its growth-by-acquisition strategy has produced several important value drivers for shareholders. Specifically, the company now has one of the broadest footprints in the nascent European medical marijuana market; it has a top-shelf production capacity of approximately 700,000 kilograms per year; and the company owns the rights to an impressive line-up of branded cannabis products through its acquisitions of MedReleaf and Whistler Medical Marijuana. Finally, Aurora also sports a strong presence in the high-value hemp space, thanks to its acquisition of ICC Labs.
The downside is that Aurora has been one of the worst offenders in the industry in terms of raising capital at investors' expense. Aurora's outstanding share count, for instance, has ballooned over this period of hyperexpansion:
ACB average diluted shares outstanding (annual) data by YCharts.
Aurora's need to repeatedly tap the public markets can be directly attributed to its inability to secure a major partnering deal. Despite exploratory talks with Coca-Cola about CBD-infused nonalcoholic beverages late last year, Aurora has so far come up empty-handed on the partnering front -- leaving its shareholders to bear the burden of this ultra- aggressive business development strategy.
Perhaps the most concerning part about Aurora's investing thesis, though, is its sky-high valuation. After this sizable run-up in early 2019, the pot titan's shares are now trading at over 30 times the company's projected 2019 sales -- and this stately figure might even be too low. Margin compression in the recreational Canadian cannabis market could become a serious problem toward the tail end of 2019, after all.
Cronos' value proposition
Cronos' most attractive feature for investors is unquestionably its partnership with Altria. This landmark deal gives the company a huge competitive advantage in the U.S. cannabis market. Putting this deal into context, the U.S. legal marijuana market is widely believed to be worth over $85 billion at peak. That's a staggering potential commercial opportunity for Altria and its partner Cronos. The catch, however, is that the U.S.cannabis market will remain a no-go zone -- for the most part -- until lawmakers end federal prohibition.
Meanwhile, Cronos will be forced to make a living mostly in the highly competitive Canadian cannabis market, which isn't a stellar prospect. Cronos' fully funded production capacity of somewhere around 150,000 kilograms per year, after all, puts it solidly outside of the country's top five producers.
The net result is that Cronos isn't expected to grab much of the Canadian recreational market in the near term. The pot company's shares are thus trading at over 58.9 times this year's projected sales. That kind of eye-popping valuation strongly implies that the market is putting a ton of faith in this Altria partnership.
To be fair, Cronos does have an intriguing partnership with Ginkgo Bioworks to produce rare cannabinoids through genetically modified yeast strains. This partnership, if successful, could put Cronos in a unique competitive position and possibly open up another multibillion-dollar market. But the hard truth is that this speculative venture isn't expected to produce any revenue for another two to three years.
Check out the latest Cronos earnings call transcript.
Takeaway
Shares of Aurora and Cronos have arguably run too hard, too fast this year. Both of these pot companies are on the cusp of a jaw-dropping commercial opportunity, but a number of legal and logistical barriers remain. Unfortunately, investors seem to have ignored these various risk factors in the rush to catch lightning in a bottle. Once these various headwinds start to make their presence felt in the next 12 months, however, these shares will probably revert to the mean in a hurry. Thus, investors might be wise to consider booking some profits before this rally runs out of steam.
