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3 Arguments For and Against Buying Cronos Group

By Sean Williams – Updated Apr 18, 2019 at 12:37PM

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Pot stock Cronos Group has been a top performer in 2019, but opinions vary wildly on where it'll head next.

When it comes to growth, investors would have a hard time finding an industry that'll deliver more than marijuana. Between 2017 and 2022, the team of Arcview Market Research and BDS Analytics foresees global cannabis sales rising from $9.7 billion to $31.3 billion. That incredible growth rate, to pair with $31-plus billion in sales, should mean long-term investors in certain pot stocks pocketing big gains.

The big question is: Which pot stocks to buy? One of the most popular yet contentious of all marijuana stocks is Cronos Group (CRON -1.66%). At one point recently, Cronos Group had doubled in a span of six weeks and was leading all marijuana stocks in terms of 2019 year-to-date gains.

A tipped-over bottle containing dried cannabis lying atop a messy pile of cash bills.

Image source: Getty Images.

As you can imagine, there are plenty of reasons for investors to be bullish on this up-and-coming cannabis grower. But there are also quite a few investors who view Cronos Group as grossly overvalued. Below, you'll find three solid reasons Cronos Group is worth buying, as well as three valid arguments why you should keep your distance.

Three reasons Cronos Group could put some green in your portfolio

Unquestionably, the most convincing reason to buy Cronos Group stock is because of tobacco giant Altria's (MO 0.94%) mammoth $1.8 billion equity stake in the company, announced in early December. Although the investment hasn't yet closed, it will give Altria a 45% stake in the company once it does. Further, Altria will be granted warrants that, if exercised at a later date, could allow for a majority stake of 55% in Cronos Group. Long story short, Cronos Group jumps to near the top of the list of pot stocks that could be acquired.

To build on this point, Altria has seen years of declining cigarette shipment volumes, and purchasing a stake in Cronos gives it access to a partner that could help with its decline in aggregate consumers. Expect the duo to potentially work on vape products and research other cannabis alternatives in the quarters to come.

A vial of cannabinoid-based oil next to a group of cannabis leaves on a table.

Image source: Getty Images.

Secondly, investors are going to appreciate Cronos Group's focus on higher-margin alternative products. Whereas dried cannabis flower is the best-known pot product, it's also the one that's the easiest to oversupply and commoditize. Meanwhile, alternative products, such as oils, aren't as easy to oversupply, and they have far fewer pricing pressures. Cronos' unique play here is its partnership with Ginkgo Bioworks for about $100 million. Cronos will gain access to Ginkgo's microorganism platform to develop yeast strains capable of producing eight different variants (some rare) of cannabinoids at commercial scale. Not only will these cannabinoids carry premium price points, but the expected cost of production should be less than traditional extraction methods.

Thirdly, dilution is about to become a concern of the past for Cronos Group shareholders. Assuming the Altria deal closes and new shares are issued, Cronos Group will have north of $1.8 billion in cash on hand, which should be more than enough capital for the company to execute its domestic and international expansion plans. With the company less likely to turn to bought-deal offerings to raise capital, at least in the intermediate term, share-based dilution will become a minimal to nonexistent concern.

Check out the latest Cronos earnings call transcript.

Three valid arguments for avoiding Cronos Group like the plague

Then again, there are two sides to every argument, and a very good case can be made for leaving Cronos Group stock on the shelf.

For starters, Cronos Group's production leaves a lot to be desired. Aurora Cannabis, Canopy Growth, and Aphria are Canada's projected top three producers with around 700,000 kilograms, north of 500,000 kilos, and 255,000 kilos, respectively, of peak production. Meanwhile, Cronos Group might scrape together 120,000 kilos of annual yield, which includes 40,000 kilos from Peace Naturals and 70,000 kilos from its flagship joint venture project that's on pace for completion by mid-2019.

A cannabis-growing greenhouse in an outdoor setting.

Image source: Getty Images.

Here's the issue: Once the Altria investment is complete and new shares are issued, Cronos is going to have a market cap of roughly $5.6 billion. But there are growers on track for between 100,000 kilos and 113,000 kilos that have market caps of between $750 million and $1.2 billion. Does $1.8 billion in cash really merit this much of a premium for Cronos when its production totals are almost identical to pot stocks with much smaller market caps? That's one concern.

Next on the list is the fact that, relative to its peers mentioned above, Cronos has done a poor job of ensuring that it has a presence in foreign markets. Cronos has established production in Israel and Australia (both of which will help it reach around 120,000 kilos in peak annual production), but it's done little else in pushing into overseas markets. This is worrisome given the propensity of dried cannabis flower to be oversupplied over time in markets where adult-use legalization has occurred (e.g., Colorado, Washington, and Oregon). If Cronos doesn't establish sales channels to overseas markets where it can offload excess supply, it could see its margins deteriorate substantially by the early part of the next decade.

Third and finally, Cronos Group's fundamentals are sort of a train wreck, and they're unlikely to improve anytime soon. Cronos is liable to take its investment from Altria and put it to work by possibly expanding its production capacity or by making acquisitions. No matter what path it takes, the company's expenses are going to soar as quickly as its revenue, leading to a good possibility of operating losses in the interim. Even if Cronos is able to generate a profit, it'll likely be small, as evidenced by the company's forward price-to-earnings ratio of nearly 470.

The question left to ask is: Where do you stand on Cronos Group moving forward?

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Cronos Group Inc. Stock Quote
Cronos Group Inc.
CRON
$2.96 (-1.66%) $0.05
Altria Group Stock Quote
Altria Group
MO
$42.90 (0.94%) $0.40

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