Cronos Group (NASDAQ: CRON) reported fourth-quarter financial results this week that failed to impress. Despite revenue jumping over 50% from the prior quarter, investors sold shares because of mounting losses. Does Cronos Group's recent tumble make it a pot stock worth buying?
A major market opportunity
Excitement over marijuana stocks stems from the opportunity for cannabis companies to tap into what Constellation Brands has said could be a global market worth $200 billion in 15 years. That's a jaw-dropping outlook for pot stocks given revenue at most of these companies, including Cronos Group, is tracking at less than $100 million per year.
The worldwide sales opportunity is based upon the fact that about $150 billion is spent on marijuana today, according to the United Nations, and spending could climb as more countries legalize marijuana and consumers embrace new products made from cannabis or chemical cannabinoids extracted from it, such as beverages.
Tapping the recreational market
Reaching the $200 billion long-term market target is going to require a lot more countries legalizing marijuana. Today, Canada is the only member of the G7 nations that's passed laws allowing for recreational adult-use, and Canada's market is tiny compared with Europe and the United States.
Canadians spend about 6 billion Canadian dollars per year on marijuana, but the lion's share of that spending happens in the black market, not in licensed medical or recreational dispensaries. In Q4 2018, Canada's spending on pot totaled CA$1.48 billion and only CA$155 million and CA$152 million were spent in licensed medical or recreational retailers, respectively.
That's far shy of what forecasters expected in the quarter. In September 2018, Statistics Canada, the Canadian government's official number cruncher, forecast legal spending of between CA$816 million and CA$1.02 billion because of its recreational marketplace opening on Oct. 17, 2018.
Nevertheless, the shifting of sales out of the shadows to regulated retailers is still a boon to Canada's top cannabis companies, including Cronos Group. In the quarter, it reported net sales rose 248% year over year to CA$5.6 million, bringing its full-year net sales to CA$15.7 million, up 285% from 2017.
With year-over-year growth skyrocketing, it might surprise you that Cronos Group's shares tumbled following its earnings release. However, it's less shocking when you start digging into the company's income statement and discover that Cronos' expenses are growing much faster than its sales.
Its fourth-quarter gross profit was CA$2.5 million excluding fair value adjustments to the value of marijuana in inventory, which translates into a gross margin of 44%. However, operating expenses, including selling, general and administrative, research, stock compensation, etc., were $12.4 million in Q4, up 328% from the same quarter in 2017. As a result, the company's fourth-quarter net loss was CA$11.8 million, or more than double its revenue. For the full year, its net loss was CA$19.2 million, an increase of over 1,100%.
How bad is it?
Since we're talking about a CA$6 billion market in Canada and a global opportunity worth $150 billion now, investors shouldn't blame Cronos Group or its peers for investing significantly to establish a foothold.
The company's also flush with cash, so it can afford to ramp up spending without running the risk of bankruptcy. It recently closed an investment from tobacco giant Altria (NYSE: MO) that boosted its balance sheet by CA$2.4 billion. Altria now owns 45% of Cronos and an option that, if exercised, allows it to pay CA$1.4 billion more to increase its stake to 55%.
Altria's expertise in branding -- it's the maker of Marlboro cigarettes -- and its deep pockets suggest Cronos has ample financial wiggle room to capitalize on opportunities, both in Canada and, possibly, in the U.S., where momentum to legalize marijuana federally is growing. So far, 10 states have passed adult-use laws, and according to Gallup, about two-thirds of Americans favor making recreational use legal nationwide.
Is Cronos worth buying?
Cronos Group's relationship with Altria makes it less risky than peers without big-name backers, but its revenue trails most of the best-known players in the space and its market cap is higher than others with more revenue, suggesting Cronos Group isn't the best bargain among marijuana stocks. Nevertheless, it has plenty of opportunity to win market share, grow sales, and, eventually, reward investors, so long-term investors looking to diversify across many marijuana stocks ought to consider this drop an opportunity to pick up some shares.
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