Marijuana companies had a dreadful 2019. The industry benchmark, the Horizons Marijuana Life Sciences ETF (HMLSF +0.00%), fell by 36%. Investors hoped things would turn around in 2020 after Canada legalized recreational cannabis derivatives (edibles, vapes, concentrates, beverages, and more) in October 2019. And then the coronavirus pandemic hit. Surprisingly, the pandemic proved favorable for pot companies in the U.S. after marijuana was deemed essential in many locales, boosting sales. Canada also made marijuana an essential item, but the situation for Canadian companies remains dire. Headwinds including fewer legal stores than expected, regulatory delays, a growing illicit market, and supply constraints distressed sales.
Toronto-based Cronos Group (CRON 0.59%) has always played it safe by not aggressively going after acquisitions, instead using cash to focus on research and development with its products. With steady revenue numbers, it has kept its balance sheet strong -- enough to at least survive the COVID-19 storm. Moreover, its partnership with tobacco giant Altria Group (MO +2.82%) keeps its pockets deep, making it attractive to investors, as cash position has been a crucial matter in the cannabis industry. But are these reasons enough to invest in the stock?
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Cronos' recent quarterly results are worrisome
Cronos is a global cannabis company that manufactures and sells medical cannabis under its Peace Naturals brand. Its recreational cannabis is available to consumers under the Cove and Spinach brands, with hemp-derived CBD (cannabidiol) products offered under the Lord Jones and Peace brands.
Cronos's revenue has grown in the past four consecutive quarters, including its recent second quarter. However, the increase is modest compared with that experienced by peer Aphria (APHA +0.00%), even though its market cap of $1.9 billion is higher than Aphria's $1.3 billion. For fiscal 2020, Aphria saw whopping triple-digit growth of 129%, to $543.3 million Canadian dollars. Cronos' net revenue reached CA$18.3 million for the first six months (ended June 30) of 2020, while Aphria saw revenue of CA$246 million for the first six months of its fiscal 2020 (which ended Nov. 30, 2019).
In its recent Q2 2020 results, Cronos's net revenue (minus excise taxes) jumped 29% to CA$9.9 million. Recreational cannabis products, along with newly launched cannabis vaporizers in Canada, drove sales in the second quarter. Cronos continued rolling out its vaporizers for the Canadian recreational market under the Cove and Spinach brands, as well as offering another line under Peace Naturals that's specifically targeted for the direct-to-consumer market in Canada. Its U.S. hemp-derived CBD business, Redwood, acquired in September 2019, also augmented revenue growth.
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Hopes for the vape market might go up in smoke
Investors viewed Cronos's partnership deal with Altria, parent of the Marlboro and Black & Mild brands, as a wise move. Altria invested CA$2.4 billion in Cronos in 2019, giving itself a 45% stake. Altria's network and its expertise in the tobacco sector seemed likely to help Cronos capture a good chunk of the U.S. market. However, in 2019, usage of e-cigarettes and vaping products was found to cause a series of lung-related injuries known as EVALI (e-cigarette or vaping use-associated lung injury). The Centers for Disease Control and Prevention determined that black-market operators using vitamin E acetate in their vape products were the cause, but demand and sales took a serious hit, even for legitimate products. And SARS-CoV-2, the coronavirus responsible for COVID-19, a disease that affects the lungs, added to consumer concerns.
In the second quarter, Cronos's adjusted operating loss increased by $18 million to CA$35 million from the year-ago period, driven by higher general and administrative (G&A) expenses and research and development costs. Cronos said G&A expenses rose 61% to CA$18.4 million as it had to increase its workforce to support its growth strategy -- but its revenue numbers say otherwise. The higher expenses also had to do with some charges related to Cronos' restatement of its 2019 interim financial statements. In March, Cronos restated items from the first three quarters of fiscal 2019. The readjustments caused a decline of CA$7.6 million from its revenue for two of the quarters, which didn't sit well with investors.
So far this year, shares of Cronos have slumped 30%, which is worse than the Horizons Marijuana Life Sciences ETF's decline of 25%. Aphria, on the other hand, has fallen 12% over the same period.
Is Cronos a good investment?
Cronos still has a lot of scope in the Israeli medical cannabis market. It began selling dried cannabis flowers there under its Peace Naturals brand in April, after receiving the necessary approvals. Management expects medical cannabis use in the country to grow, spurring more use of its pre-rolls and oil products, which will receive their final licenses later this year. Israel's medical marijuana market is rather small, but strict border restrictions could keep the black market at bay.
Cronos could likely survive the pandemic thanks to its influx of cash on hand. At the end of the second quarter, it reported cash and cash equivalents of $CA1.1 billion. But its recent adjustments to revenue made investors reticent to trust its financial statements. Besides, its lower revenue growth compared with its peers makes its growth strategies questionable. For now, it would be wise to steer clear of this pot stock until it shows some drastic revenue gains or positive profitability.
