Cronos Group (CRON -1.66%) ranks as the most hated pot stock around, according to my colleague Sean Williams. And Sean makes a pretty good point. Analyst after analyst has downgraded Cronos stock over the past few months. The stock is down 30% from its highs set in early March.
Why is everybody hating on Cronos Group these days? They think it's overvalued. They don't think the company's capacity comes close to stacking up with other major players in the industry. And some are skeptical about Cronos' international prospects.
But when pessimism about a stock reaches a certain level -- as it has with Cronos -- I like to look at things from a contrarian viewpoint. I actually think the stock could double or more over the next three to four years. Here are three reasons why.
Image source: Getty Images.
1. Tobacco road
Probably the most compelling reason Cronos Group could at least double over the next three years relates to the company's partnership with Altria (MO 1.91%). The tobacco giant announced in December 2018 that it was forking over $1.8 billion for a 45% stake in Cronos. That transaction closed in March.
There are plenty of benefits to Cronos Group from its relationship with Altria. The cash and expertise Altria brings to the table should make a huge difference for Cronos down the road. But there's one aspect of the Altria deal that I think could especially lead Cronos to rack up a huge gain within the next few years.
Altria owns a warrant to buy another 10% of Cronos Group that, if exercised today, would cost $1.4 billion Canadian, or around US$1 billion. If you do the math, this transaction would peg Cronos' total valuation at around $10 billion -- nearly twice what Cronos' market cap is today.
To be sure, Altria might not exercise this warrant. But the big tobacco company has four years from March 2018 to add to its position in Cronos Group. I wouldn't be surprised at all if Altria does indeed exercise its warrants on or before that date.
2. Rising yeast
Cronos Group could have another major catalyst before the clock runs out on Altria's warrant. The company teamed up with Ginkgo Bioworks last year on an effort that could disrupt the cannabis industry.
Ginkgo is working on genetically engineering yeast strains to produce high-quality cannabinoids. The small biotech thinks it will be able to produce these cannabinoids at a much lower cost than current methods where cannabinoids are extracted from cannabis plants.
The important thing for investors to note about this partnership is that Ginkgo has until September 2021 to reach the pivotal milestone of producing eight cannabinoids at a cost of less than CA$1,000 per kilo and at a scale of more than 200 liters. If this milestone is met, Ginkgo will receive up to 14.7 million Cronos Group shares.
At Cronos Group's current price, Ginkgo stands to make nearly $240 million if it's successful. That is a nice financial incentive for the biotech. And if Ginkgo does succeed, Cronos will be in a position to deliver cannabinoids at much lower costs than its peers. That just might be enough to make the stock double even without other catalysts.
3. Change in the air
Yes, many observers are valuing Canadian marijuana producers largely based on their production capacities right now. And, yes, Cronos lags behind several of its peers on that front. This capacity-based valuation makes sense with supply being the limiting factor, especially in Canada's adult-use recreational marijuana market.
But demand will catch up with supply in Canada probably within the next couple of years. That will change the dynamics considerably on how people view marijuana stocks. Cronos CEO Michael Gorenstein said in the company's Q4 conference call that Cronos will focus "on making the cheese rather than raising and milking the cows." In other words, Cronos is less concerned about growing cannabis as it is on developing products that include cannabis. This focus could make the company more valuable in the future than it is now.
Probably the more impactful change that could be on the way, however, is the potential legalization of marijuana in the United States. Legislation has been introduced in both the Senate and the House of Representatives to change federal marijuana laws. The bill seems very likely to pass in the Democratic-controlled House. It will also probably pass if brought up for a vote in the GOP-controlled Senate.
Even if efforts to change federal marijuana laws fail this year, there's a big U.S. election next year. All of the current presidential candidates (including President Trump, by the way) support efforts to allow states to enforce their own marijuana laws. It's possible and perhaps even likely that the Senate could flip to the Democrats, virtually ensuring the passage of legislation to revise current U.S. marijuana laws.
Should marijuana laws open the door for Cronos to enter the huge U.S. market, it's quite conceivable that the stock could double. It would also almost certainly increase the odds that Altria would exercise its warrant to buy another 10% of the company.
But hate away for now
I think all three of these factors are absolutely in the realm of possibility. The catch is that it could take a few years for them to benefit Cronos Group.
In the meantime, there might not be many catalysts to help Cronos stock rebound. Haters of Cronos could be safe in hating away for now. Over the longer run, however, I think this hated stock could generate more love from investors than seems possible at the moment.
