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5 Questions Cronos Group Must Answer With Its Third-Quarter Report

By Sean Williams - Nov 8, 2019 at 7:51AM

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Is there promise or peril on the horizon for one of the most popular pot stocks in the world?

Although earnings season never actually ends, it's about to pick up in a big way for the marijuana industry. Next week, some of the largest and most popular cannabis stocks are set to lift their respective hoods on their latest quarterly performance. One of these pot stocks hoping to dazzle Wall Street is Ontario-based Cronos Group ( CRON 4.40% ).

Cronos is set to release its third-quarter operating results before the opening bell on Tuesday, Nov. 12. According to Wall Street's consensus, the company is expected to report 11.1 million Canadian dollars in sales, representing a 291% increase from the year-ago period, with CA$0.03 per share in losses, matching its per-share loss from Q3 2018.

A businessman in a suit pressing the quarterly report tab on a digital screen.

Image source: Getty Images.

Forget the headline numbers, and look for answers to these questions instead

However, Cronos Group's headline figures really shouldn't be the story here. Persistent supply issues in Canada are liable to have constrained its sales growth, which is a trend that's been apparent throughout the country. Furthermore, the company's bottom-line has been greatly impacted by revaluations to its derivative liabilities (i.e., warrants tied to Altria Group's ( MO 0.14% ) equity investment in the company) in recent quarters. The point being that sequential quarterly sales growth should be subdued, and Cronos will lose money on an operating basis, once one-time benefits and fair-value adjustments are removed from the equation.

What investors should really be on the lookout for is an answer from management, or within the company's quarterly report, to the following five questions.

A large dried cannabis bud lying atop a messy pile of cash.

Image source: Getty Images.

1. What's the plan for the company's large cash pile?

In March, Cronos Group closed on the aforementioned equity investment from Altria that earned the company $1.8 billion in cash in return for a 45% nondiluted stake in the company. This cash is expected to be critical to supporting Cronos Group's growth strategy.

For example, the company announced in early August that it would acquire Redwood Holding Group, which owns the Lord Jones line of cannabidiol (CBD)-based beauty products. CBD is the nonpsychoactive cannabinoid that's best known for its perceived medical benefits. Whereas most marijuana acquisitions are completed as all-stock deals, Cronos used $225 million of its cash to account for the $300 million price tag. This should leave the company with north of $1.5 billion in cash on hand, as of Sept. 30.

The question is, "What's next?" Sure, this cash provides a healthy downside buffer to Cronos Group's share price, but with the company continuing to lose money on an operating basis, investors are going to be antsy to see how the company plans to put this capital to work. With plenty of market share still up for grabs, look for Cronos to provide a more specific outline of what it plans to use its cash for in the coming six to 18 months.

A cannabis leaf on top of foam in a glass, with cannabis leaves set to the right of the glass.

Image source: Getty Images.

2. How badly (if at all) has the derivative launch delay impacted the company's growth plans?

Regulatory agency Health Canada has failed the pot industry in a variety of ways. Most notably, it's not been able to review cultivation, processing, and sales license applications in a timely manner, resulting in very long wait times for growers to get the go-ahead to produce or sell their product.

However, Health Canada also dropped the ball on the launch of derivatives (e.g., vapes, concentrates, topicals, edibles, and infused beverages). The expectation had been that these considerably higher-margin products would hit dispensary shelves by no later than October 2019, the one-year anniversary of recreational weed sales in Canada. But Health Canada noted midyear that derivatives wouldn't begin hitting dispensary shelves until mid-December, despite regulations governing these products going into effect on Oct. 17, 2019.

It's no secret that Cronos Group has shied away from becoming a big-time cannabis producer and has, instead, focused its efforts on growing into a cannabinoid giant. Essentially, it wants to be a major player in the high-margin derivatives space. But with derivatives launching a few months later than anticipated, and many of the same supply issues expected to impact derivative supply in retail stores, it'll be interesting to see what sort of impact Cronos is seeing from these "maturation hiccups." Pay close attention to management commentary on the commencement of derivative sales in the company's management discussion and analysis (MD&A), filed with SEDAR.

A young man with a beard and wearing sunglasses who's exhaling vape smoke while outside.

Image source: Getty Images.

3. Are vaping concerns hurting the company's sales/profit outlook?

Since the summer, the Centers for Disease Control and Prevention (CDC) in the U.S. has reported 2,051 cases of confirmed or probable mystery lung illnesses associated with vaping. These lung illnesses have also caused 39 deaths as of Nov. 5, 2019. Although the CDC isn't certain what's causing these issues, it has recommended that consumers avoid vaping liquids containing tetrahydrocannabinol (THC), the cannabinoid that gets users high. 

Even though Cronos Group doesn't operate in the U.S., this is still front-and-center news given that its partnership with Altria places it firmly in the discussion as a major player in the vaping space in Canada. In fact, Cowen Group estimated in March that vape revenue would lead all other derivatives in sales in the United States. The expectation is that Canada's sales breakdown will be similar.

How will these vaping-related health concerns impact Cronos Group's rollout of vape products and its partnership with Altria? This might be one of the biggest questions Cronos is going to need to address in its quarterly report or via the MD&A.

A gloved processor holding scissors while trimming a cannabis flower.

Image source: Getty Images.

4. Will Cronos follow its peers on cutting back jobs or output?

Despite cannabis being projected as one of the fastest-growing industries on the planet over the next decade, near-term growing pains have significantly reduced growth expectations throughout North America. As a result, some of Cronos Group's peers have responded with production and/or jobs cuts.

Quebec-based HEXO ( HEXO 10.23% ), for example, recently announced that it would be laying off 200 workers from a variety of departments. HEXO also plans to idle its Niagara grow farm, which was acquired via the Newstrike Brands purchase. This, along with slow-stepping its Gatineau expansion, effectively reduces HEXO's peak annual output to about 80,000 kilos from 150,000. The company blamed the slow rollout of physical dispensaries, the delayed launch of derivatives, and recent legal weed per-gram price weakness for its decision to scale back jobs and production.

What investors should pay close to attention to is whether Cronos Group will follow its peers in cutting back output. My suspicion is that it probably won't, primarily because it's not a major cannabis grower like HEXO. However, with vaping concerns rearing their head and supply issues in Canada unlikely to be resolved for many quarters to come, job cuts or an ebb in production expansion isn't out of the question.

An accountant chewing on a pencil as he closely analyzes figures from his printing calculator.

Image source: Getty Images.

5. When will the company turn the corner to profitability?

Finally, just in case you'd forgotten, earnings do matter when it comes to marijuana stocks. With the passage and implementation of the Cannabis Act in Canada, the days of promises being enough to bolster pot stock valuations has come and gone. Nowadays, Wall Street wants to see sustained bottom-line improvement.

When Cronos reports its Q3 results, the company is going to lose money on an operating basis, even if it generates another surprise "profit" from revaluing its derivative liabilities. But the question is whether Cronos sees its bottom line moving in the right direction. Will the company take a page out of Green Organic Dutchman's book and significantly reduce capacity expansion and expenses in order to push toward positive operating cash flow? Or will Cronos Group's cushy cash position encourage it to remain aggressive and push its forecast for profitability further down the line?

Whether it's in the company's quarterly press release, buried in its MD&A, or answered via a conference call with analysts, look for answers as to when Cronos Group expects to be profitable or at the very least generate positive adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization).

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Cronos Group Stock Quote
Cronos Group
$4.51 (4.40%) $0.19
Altria Group, Inc. Stock Quote
Altria Group, Inc.
$44.49 (0.14%) $0.06
HEXO Stock Quote
$1.08 (10.23%) $0.10

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