Canada's marijuana market is valued at 6 billion Canadian dollars annually, and legalization of recreational use last October means sales are skyrocketing at the country's top marijuana producers. One of the smallest marijuana growers in Canada, Cronos Group (CRON +1.80%), has captured investors' attention following a CA$2.4 billion investment in it by tobacco giant Altria (MO 0.53%). The relationship with the maker of Marlboro cigarettes means Cronos Group has the financial flexibility and the marketing and supply chain expertise necessary to leapfrog competitors. On Thursday, the company unveiled its latest quarterly results, providing insight into its progress. Here's what you need to know following the company's update.
No. 1: Sales are still soaring
Cronos Group's first-quarter net revenue was CA$6.5 million, up more than 120% from CA$2.9 million in Q1 2018 and 15% quarter over quarter. The sales increase was mostly due to an uptick in sales of cannabidiol (CBD) oil, a high-margin product derived from marijuana and hemp that's associated with health and wellness benefits. Cannabis oil sales represented 23% of net product revenue in the quarter, up from 9% in first quarter 2018.
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On a volume basis, Cronos Group sold 1,111 kilos of cannabis in Q1, a 122% improvement from one year ago and a 7% improvement from the fourth quarter.
No. 2: Cheaper production
As more marijuana production capacity comes online throughout the industry, the most profitable companies will likely be those with the lowest production costs. In Q1, management's cost of sales was $2.69, a 14% decrease from one year ago and an 11% decrease from Q4 2018. The decrease was driven by increased productivity, and it contributed to gross margin improving to 54% from 47% last year. Gross margin was 44% in the fourth quarter, so there was a solid sequential improvement too.
No. 3: Growing capacity
The company's current facilities can produce about 40,100 kilos of marijuana annually once its building 4 expansion is fully operational, but that's less than half of the cannabis capacity Cronos Group anticipates. Based on its existing expansion plans, its peak production capacity will reach 117,150 kilos annually. That should be good enough to place it at the lower end of the second-tier marijuana growers.
No. 4: Flush with cash
In March, Altria completed its investment in Cronos Group, causing Cronos Group's cash and equivalents to soar. In exchange for 45% ownership, Cronos Group pocketed CA$2.4 billion from Altria, giving it substantial financial flexibility to execute on its plans to win market share and develop new products, including vapes.
No. 5: Increasing distribution
Cronos Group doesn't market its products everywhere in Canada's recreational market, but following an arrangement that gives it access to Saskatchewan, it now serves 5 of Canada's 10 provinces, allowing it to reach 58% of Canada's population.
No.6: Profit? Not really
The company reported net income of $427.7 million. However, as you can guess by the size of this profit, it had little to do with the company's day-to-day operations. Instead, the profit was almost entirely because of changes in a gain in the value of warrants issued to Altria that allow Altria to increase its ownership to 55% by 2023. These derivative liabilities are valued based on Cronos Group's share price. Since Cronos Group's shares declined last quarter, the company recorded an unrealized gain of $436.4 million in the quarter.
The profit was also helped by the sale of its 19% ownership stake in Whistler Medical Marijuana to Aurora Cannabis. In exchange, Cronos Group received $25.6 million Aurora Cannabis shares, which it subsequently sold.
Partially offsetting those "other income" items on its income statement were $29.6 million in financing costs, which includes legal and professional expenses associated with its Altria transaction.
No. 7: Operating costs continue climbing
On an operating basis, the company lost money. Its operating expenses surged to 214% of sales from 139% of sales one year ago, largely because of a major increase in general and administrative spending in support of its recreational marijuana market activities.
| Operating Expense | Q1 2019 (000s) | % of sales | Q1 2018 (000s) | % of sales |
|---|---|---|---|---|
| Sales and marketing | $1,500 | 23% | $586 | 20% |
| Research and development | $1,557 | 24% | ||
| General and administrative | $9,611 | 149% | $2,461 | 83% |
| Share-based payments | $737 | 11% | $774 | 26% |
| Depreciation and amortization | $470 | 7% | $285 | 10% |
| Total operating expenses | $13,875 | 214% | $4,106 | 139% |
Overall, it was a lot more of the same from Cronos Group. Sales continued climbing as it made inroads into Canada's recreational market, and expenses continued to skyrocket as it increased headcount to win market share.
Perhaps the biggest takeaway from the quarter wasn't its operating performance at all but the fact it hasn't yet announced any big plans for its cash stockpile. With more than CA$2 billion at its disposal, it probably won't be long before we find out how management plans to leverage that windfall to become a top player in this emerging $150 billion global market.
