With $1.1 billion in cash and cash equivalents on hand, Cronos Group (CRON 0.66%) has the resources and stability that many cannabis companies envy. It also has a partner in tobacco company Altria Group, which has owned a 45% stake in the cannabis producer since 2018. Altria's $1.8 billion investment is a main reason Cronos enjoys such a large stockpile of cash today.
But stability alone isn't enough to make Cronos a good investment. Investors have concerns about the company's sales growth and the consistency of its earnings, and unfortunately, Cronos's most recent quarterly results did nothing to put those to rest. Here are three numbers from the second-quarter results that should give potential investors pause.
1. Zero percent sales growth in existing markets
On a consolidated basis, Cronos's top line rose by 29% from the prior-year period, up to $9.9 million in net revenue. However, that was mainly due to $2.2 million in revenue from its U.S. segment -- a component of the Canadian company's business that didn't exist a year ago. In August 2019, Cronos acquired Redwood Holding Group for $300 million, which gave it access to the U.S. cannabidiol (CBD) hemp market, including Redwood's flagship CBD brand, Lord Jones.
Nevertheless, outside of the U.S. market, in what Cronos now calls the "Rest of World" segment, there wasn't much of a change in sales. Its revenue of $7.7 million was only 1% higher than the $7.65 million Cronos recorded a year ago.
This is especially concerning given broader consumer trends. In the early months of the coronavirus pandemic, sales in the Canadian cannabis industry were up as people stockpiled whatever they deemed essential. Pot-producing Aphria, for example, recorded 152.2 million Canadian dollars in revenue in its most recent quarterly results, more than 10 times Cronos' sales. The consumer demand felt by most players failed to translate into a material sales increase for Cronos. This should concern a company that's nowhere near the industry leaders in terms of market share.
2. $40 million in impairment charges
To add insult to injury, Cronos incurred an impairment charge that was four times its net revenue. These impairment charges refer to a reduction in the value of a fixed asset. A $35 million impairment charge on its U.S. units was coupled with a $5 million charge on Lord Jones. The total impairment, along with revaluation losses on derivative liabilities totaling $35.9 million, is a key reason why the company's net loss ballooned to $107.7 million in Q2, down from a profit of $185.9 million a year ago. Last year's number was high mostly due to revaluation gains of $197.3 million.
Management blamed COVID-19 and its accompanying store closures, which they said had a negative impact on sales and overall demand in Q2. They expect continued weak demand in the near future, which led to the company recording a $3.1 million inventory writedown this period.
All of this is especially concerning because it comes as many states are reporting record cannabis sales, indicating that the industry as a whole is not faring badly amid the COVID-19 pandemic. Colorado reached a record of $199 million in monthly cannabis sales for the month of June, and California sales hit $348 million in a record-breaking July.
If management is projecting weaker sales than anticipated, it may have more to do with the demand in the CBD hemp market as opposed to demand for cannabis in general. Unless Cronos is simply being overly conservative in its projections, there may be more writedowns to come if the industry slows altogether.
3. A 61% increase in general and administrative costs
If sales are rising at a higher rate than expenses, it's easy for investors to stomach higher production costs. But that's not the case for Cronos. Its operating expenses of $31.8 million were up 52.5% from last year's $20.8 million. General and administrative costs have risen especially quickly. The company's administrative-related expenses totaled $18.4 million in Q2 and climbed more than 60% from the year-prior period.
That's a much higher number than its 29% rate of sales growth, so investors should keep an eye on it. Management said the cost bump was due to an increase in employee headcount to support its growth strategy. The problem is that there really hasn't been much organic growth to show for it. And according the company's own outlook, there may not be much in the future.
Cronos is a scary stock to own
There are many scary investments in the cannabis industry, but Cronos is near the top of the list. So far this year, shares of Cronos are down 24%, which is slightly worse than the Horizons Marijuana Life Sciences ETF (HMLSF 1.00%), down 21% over the same period. With poor sales growth and with significant volatility in its financial statements, this is not a pot stock I'd feel good holding in my portfolio.