Cannabis investors sometimes have to take earnings results with a grain of salt. Relying just on sales and net income figures can lead to incorrect conclusions. And in an industry as dangerous and risky as this one, investors need to exercise caution.
Marijuana producer Cronos (NASDAQ:CRON), for instance, is coming off a quarter in which it recorded a strong profit, and it has a significant amount of cash on its books. But a closer look at the company's results highlights some serious concerns about why investors shouldn't be rushing out to buy shares of Cronos.
The company's profits have been extremely misleading
Cronos has recorded a positive net income figure in each of its past five quarterly results. It's been remarkably consistent in producing a profit, and normally, that would make the stock an attractive buy. But those results have been skewed by other income amounts that propelled the company from the red into the black.
In Cronos's first-quarter results, released May 8, the company's net income came in at $75.7 million on revenue of just $8.4 million. Without other income of $120.7 million, the results would've looked a lot different. A $113.4 million revaluation gain on derivative liabilities was largely the reason for the company's positive net income number during the quarter. What's surprising is that's actually much lower than a year ago, in the first quarter of 2019, when the company benefited from a revaluation gain of $328.2 million.
Looking at operating income can often paint a more accurate picture. In the first quarter, Cronos reported an operating loss of $45.1 million, and it has consistently incurred an operating loss in each of its past 10 quarterly results. The Canadian pot producer's operating expenses of $38.6 million easily eclipsed its top line during the first quarter and if that trend continues, there won't be much hope for investors that the company will be able to get anywhere near breakeven anytime soon.
Cronos will likely survive the pandemic, but that's not enough of a reason to invest
When tobacco company Altria Group (NYSE:MO) invested $1.8 billion in Cronos back in 2018, it injected the cannabis company with a tremendous amount of cash. As of March 31 of this year, Cronos still had cash and cash equivalents on its books totaling $1.1 billion. And given that the company burned through just $38.9 million in its operations over the first three months of the new fiscal year, Cronos is in a solid position to handle that rate of quarterly cash burn, which is just about 3.5% of its cash balance.
That's why Cronos is a safe bet to survive the pandemic, as it has a boatload of cash available. But the problem with Cronos was never related to cash. It's that the stock's just grossly overpriced for the level of sales growth that it's generated. With only $8.4 million in revenue in the first quarter, the company's not generating nearly enough to justify its $1.7 billion market cap.
OrganiGram Holdings (NASDAQ:OGI) generated 23.2 million Canadian dollars in its most recent quarter, and the company's market cap is a mere $215 million (U.S.). To put into perspective how overpriced Cronos is, here's how it compares with some of its Canadian peers:
The stock's not even in the same stratosphere as other pot stocks. It also doesn't help that Cronos had to restate its financial results for the first, second, and third quarters of 2019 because of errors made in transactions that led to (downward) adjustments in sales. Investors have likely lost a bit of trust in Cronos as a result, and the stock should be trading at a discount relative to its peers rather than at a significant premium.
Investors should steer clear of Cronos
A high valuation, low market share, and mounting operating losses are just three reasons investors should avoid Cronos. There are simply better pot stocks to invest in today that can provide better long-term prospects for investors.
Cronos is a great example of a situation in which the numbers don't tell the whole story, showing us why it's always important to dig a little into the results to determine whether a company's numbers are as impressive as they appear to be at first glance. In Cronos' case, they aren't, and that makes the stock likely to incur further losses.
In the past 12 months, shares of Cronos have fallen by 68%, which is a few percentage points better than the Horizons Marijuana Life Sciences ETF (OTC:HMLS.F) has done over the same period. But given its steep valuation, there's a lot more room for Cronos' stock to fall.