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Near Its 1-Year Low, Is Cronos Group a Buy?

By Eric Volkman – Dec 17, 2019 at 8:00AM

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Times are tough for marijuana stocks, but perhaps this one can bounce back and make investors some money.

It'll surprise absolutely no one who follows marijuana stocks that Cronos Group's (CRON 0.52%) stock is near the bottom of its one-year trading range. At the most recent closing price of $7.28, it's barely a dollar higher than the floor it hit last month.

Naturally, when a stock scrapes the bottom, it becomes natural to ask whether it's undervalued. Should investors, then, consider buying shares of Cronos now?

A marijuana bud burning, turning from green to black

Image source: Getty Images.

Green means red

Cronos' fundamentals aren't the best, even within the famously struggling cannabis industry. However, much of this can be blamed on the North American marijuana market as a whole. Yes, all forms of recreational cannabis are now legal in Canada, but licensing and supply issues are making it tough for any company in the weed ecosystem to succeed.

The situation is hardly better in the U.S., where recreational legalization remains the exception rather than the rule in our states. High taxes on cannabis flower also limit the great potential of the legitimate market. 

Even with those daunting challenges, though, Cronos is facing significant issues. Revenue has been growing at double-digit rates on both a sequential and a year-over-year basis. Yet that's more a function of a quickly expanding market for cannabis than anything else; a score of other publicly traded pot companies are experiencing the same dynamic.

The company's Q3 net profit of nearly 788 million Canadian dollars is an illusion; it was entirely due to a revalutation of derivative liabilities on warrants owned by the company's major shareholder, tobacco giant Altria Group (MO 1.17%). This revalutation meant a paper gain of CA$835 million, so obviously without it, Cronos would have landed well in the red. Looking at a more revealing number -- the company's adjusted EBITDA loss -- it was notably deeper in Q3 than in the preceding quarter, and far more underwater than in Q3 of fiscal 2018.

Other trailing results don't bode well for the company's future. Costs are increasing at a faster pace on a year-over-year basis than gross revenue -- the Q3 rate for operating expenses was nearly 400%, while that for the top line was only 255%. 

And there's the specter of goodwill impairment. Following Altria's investment of $1.8 billion into the company, Cronos went shopping earlier this year, buying high-end U.S. CBD product line Lord Jones. That deal closed during Q3, a development we might notice only by the leap in Cronos' goodwill.

There's nothing wrong with paying above market for a choice asset, but Lord Jones looks as if it might be overvalued by more than 70%. And the resulting goodwill figure for the quarter -- almost CA$215 million -- will almost certainly have to be written down. Such a ticking financial time bomb can blow a hole in the company's profitability and in its balance sheet, which is probably the last thing it needs given its other struggles.

Reasons to be cheerful?

Certainly not all is bleak or hopeless for Cronos. Those licensing and supply issues up north will only get better, although since the roots of them are basically cumbersome federal government agencies (Health Canada) and certain stick-in-the-mud provinces (hello, Ontario!), this may take a while.

There's also that Altria money; at the end of Q3, Cronos still had a nice pile of cash, equivalents, and short-term investments that total just under CA$2 billion on its books. That's a lot to help it get through the hard times. In fact, Altria's and Cronos' relationship seems quite healthy, with the former apparently agreeing to sell the latter's upcoming PEACE+ hemp-derived CBD line of products via its considerable sales and distribution network. 

However, this is a challenging period for all cannabis companies, and such times show the skill and resiliency of entities experiencing them. Given Cronos' recent performance and the self-inflicted issues looming in front of it, I don't think the company is passing the test. I'd consider other marijuana stocks before I'd buy this one; for now, until I see some improvements in those scarier fundamentals, I'd give it a miss.

Eric Volkman 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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