Better Know a Marijuana Stock: Cronos Group

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Chances are that if you looked around, you'd struggle to find an industry with as robust a growth rate as legal marijuana. In fact, over the trailing year, the average marijuana stock has risen by more than 100%.

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Why such bullishness? Legal sales' growth figures and a growing favorability toward marijuana have played a big role. A 2016 survey from Gallup, and a more recent poll from CBS News in April of this year, found that a record number of Americans (60% and 61%, respectively) want to see pot legalized across the country.  Add the icing on the cake, which in this case is an estimate from cannabis research firm ArcView that North American legal sales growth should average 26% through 2021, and you have every reason for marijuana stock investors to believe this industry could be the greatest thing since sliced bread. 

However, there's a vast sea of marijuana stocks for investors to choose from, and emotions surrounding the industry are running high. The concern is that some investors may be buying into marijuana stocks without fully understanding the risks involved.

With this in mind, we're taking the time to periodically analyze a marijuana stock until we've covered all of the major players in the industry with a market cap of at least $200 million. Here are the marijuana stocks we've covered so far:

Today, we're going to take a closer look at Cronos Group (NASDAQOTH: PRMCF).

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What Cronos Group does

Whereas most weed businesses are working harder than ever to increase their grow capacity, Cronos Group is a company that's trying to work smarter. Based in Canada, Cronos Group is an investment firm that primarily invests in Canadian-based pot companies involved in Canada's medical-marijuana industry.

Cronos has complete ownership in three companies: 

  • Peace Naturals.
  • In the Zone.
  • Whistler Medical Marijuana Company (WMMC).

All three of these wholly owned subsidiary produce and sell medical cannabis, with WMMC and Peace Naturals also focusing on cannabis oils.

Cronos also has strategic investments in three additional companies:

  • ABcann.
  • Hydropothecary.
  • Evergreen Medicinal Supply.

Promise and opportunities

The biggest opportunity for Cronos Group, and the elephant in the room for Canadian marijuana stocks, is legislation working its way through the Canadian parliament that could legalize recreational marijuana by as soon as July 1, 2018. The Canadian government has estimated that the legalization of recreational weed would add $5 billion to $7 billion in annual revenue, and it'd likely create an immediate surge in demand for cannabis. Considering that Cronos has all three of its wholly owned subsidiaries prepared to take advantage of a possible recreational green light, it could see a surge in revenue, and the underlying value of its investments, in the years to come.

Second, take note of the diversification that comes with being a principal investment company. While it clearly has a lead investment in Peace Naturals, which recently announced a 315,000-square-foot expansion that includes a 286,000-square-foot facility,  Cronos' half-dozen investments ensures that it isn't wholly reliant on a single company. Should problems arise at one company, or sales slow, Cronos Group can lean on its other subsidiaries and investments as a hedge.

Cronos Group also stands to benefit from strong medical-marijuana growth in Canada, regardless of whether recreational weed becomes a thing next summer. According to Health Canada, which oversees the health of its country's citizens, as of May, the number of registered clients in Canada's medical cannabis system has been growing by an average of 10% per month. That should create ample growth opportunities for Cronos' wholly owned licensed producers.

Risks and concerns

No company is perfect, and Cronos Group does have a number of risks and concerns to be wary of.

Perhaps the biggest concern comes from the same Health Canada data released in May. While growth in the country's medical-cannabis business has been exceptionally strong, Health Canada is also making the process to obtain a license to produce and sell marijuana a lot easier in the months to come. What this means for Cronos Group's subsidiaries is the likelihood of an influx of competition. More competition would be expected to increase marketing costs and reduce pricing power, thus lowering margins for Cronos and its subsidiaries.

Second, investors have placed a lot of weight behind the idea of having Canada legalize recreational weed come July 1. However, Prime Minister Justin Trudeau has led this same charge before, unsuccessfully. There's also a well-defined opposition to legal pot's expansion in Canada. Concerns exist over tax revenue for regulating the industry, ensuring that minors don't have access to the drug (a home-grow option is currently being considered), and how drivers who are under the influence of marijuana will be tested and/or punished by law. This isn't to say Cronos can't still benefit from medical-cannabis growth, but recreational pot is a far bigger market.

Lastly, investors need to realize that Cronos Group is currently losing money, and its primary means of generating capital in the near term, unless Canada legalizes recreational weed, is likely to be through common stock issuances. This is a fancy way of saying that Cronos Group is raising cash at the expense of its shareholders who'll find their existing shares diluted in value. Since its inception in 2013, the company's share count has grown from about 12 million to more than 125 million as of the end of Q1 2017, and its accumulated deficit, an aggregate of all of its quarterly losses, has increased to roughly $5.6 million. 

Should you buy Cronos Group?

Now for the $64,000 question: Is Cronos Group a marijuana stock you should buy?

On one hand, investors have to like the idea of a diversified investment company, because it'll spread your risk around within the legal weed industry, and investment companies tend to have an exceptionally low cost structure due to their lower overhead expenses. If Canada winds up legalizing recreational weed next year, Cronos would appear to be a prime beneficiary.

On the other hand, Cronos doesn't look as if it'll be generating a profit anytime soon, and further investments will probably require additional share issuances, which limits the upside for any shareholders. What's more, as noted, competition in the legal-cannabis space is about to get a whole lot more competitive in Canada.

The verdict? This writer would suggest that marijuana-stock investors be patient with the industry and stick to the sidelines until we have better clarity on what'll happen in Canada.

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Sean Williams has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.