The struggles faced by the cannabis industry are plentiful -- lower-than-expected revenue, rising black-market competition, regulatory scandals. Now with the COVID-19 pandemic, few cannabis companies seem capable of surviving the crisis to continue growing. I feel Cronos Group (CRON 3.60%) is one that can.
True, Cronos might not yet have seen a drastic increase in revenue or positive EBITDA (earnings before interest, taxes, depreciation, and amortization). But it has managed to stay afloat amid the struggles of the cannabis sector and the market as a whole. Let's dive into its first-quarter results, reported May 8, to understand how it is planning to survive the crisis.
Rising revenue: a positive sign
The marijuana industry had been suffering from declining revenue for a while before the pandemic, but COVID-19 has actually proved beneficial for the sector -- once marijuana was deemed an essential item in Canada and most U.S. states where it is legal, sales increased. Cronos wasn't the only cannabis company to see an increase in revenue in the most recent quarter -- 75.1% year-over-year growth, to be specific, for a total of 11.3 million Canadian dollars. That was also up from CA$9.6 million in the fourth quarter of fiscal 2019.
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Recreational cannabis products contributed to revenue growth, with the launches of a few cannabis 2.0 products -- like vaporizers -- driving sales in the first quarter. Cronos has been rolling out its vaporizers for the Canadian recreational market under the Cove and Spinach brands, with another line, Peace Naturals, being introduced most recently in March. These products are targeted for the direct-to-consumer market in Canada. Additionally, its U.S. hemp-derived CBD business, Redwood, which Cronos acquired in September of last year, added to revenue growth.
While revenue is rising, Cronos continues to report operating losses -- CA$45.1 million in Q1, owing to higher general and administrative expenses and research and development costs. It also saw an inventory writedown of CA$8 million in the quarter. Management said pricing pressure contributed to the writedown, and they expect further declines in the near term.
Israel's medical cannabis market is a good opportunity
Cronos is employing extra health measures to stay operational amid COVID-19, and management has said they have sufficient inventory and materials to meet the current demand. That said, there are worries about COVID-19 restrictions affecting the supply chain; as CEO Mike Gorenstein said on the earnings call, "We will continue to closely monitor the rapidly evolving COVID-19 situation as well as how the opening of different regions will impact the business, our consumers, employees and our supply chain."
Management sees great opportunity in the medical cannabis market in Israel, where regulation is improving. Cronos has received the necessary approvals to produce and sell dried cannabis flowers in Israel, and management currently expects to be selling Peace Naturals-branded products in the Israeli medical market by the second quarter. The number of medical users there could grow rapidly, and management expects approvals for pre-rolls and oil products to come through this year, which could also be a huge growth driver. Plus, the Israeli cannabis market has strict border controls that should help to keep the black market in check.
Innovative cannabis 2.0 products and a stronger balance sheet
One of the most intriguing things about Cronos is its focus on producing cannabinoids more cheaply and efficiently via biosynthesis. In the first-quarter earnings report, management noted that they have successfully fermented one cannabinoid by biosynthesis through their partnership with Ginkgo Bioworks. Once successful with commercializing this technology, Cronos will have a competitive edge over its peers.
Cronos ended the first quarter with about CA$1.3 billion in cash and short-term investments, a decline of CA$171 million from the fourth quarter of 2019. However, management said volatility in exchange rates was the cause of the decline and that investors need not be concerned. Cronos handles its capital expenditures in a strategic manner; the CA$7.5 million it spent in the first quarter mostly went toward investments in its Peace Naturals campus and its fermentation efforts. It also invested a significant amount in its Israeli facility and in innovations to device technology at its Cronos Device Labs.
Cronos ended this quarter with no debt (mostly because of Altria's (MO 0.63%) CA$2.4 billion investment in it in 2019), while peer Aurora Cannabis (ACB 7.17%) had to go through a reverse stock split to save its stock from getting delisted and to strengthen its cash position. The deal with Altria, a big tobacco manufacturer, was a wise move on Cronos's part. Cronos can use Altria's network in the U.S. and its experience in the tobacco sector to capture a good chunk of the U.S. market with its cannabis vaporizers.
While cannabis stocks are doing better this year than in 2019, the global market crisis, questions of legality, restrictions on sales, and other factors are still weighing on the sector. Cronos stock is down 8.1% so far in May, while the SPDR S&P 500 ETF (SPY 1.01%) has gained 1.33%.
A long way from over
Investing in an evolving sector requires patience, an appetite for risk, and a focus on long-term growth. If the short-term headwinds in the marijuana sector are making you anxious, you're not alone! That said, medical cannabis opportunities in Israel, legalization of marijuana in more U.S. states, and strong financial support from tobacco giant Altria give Cronos a lot of advantages that marijuana investors will want to consider for the long term.
