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Is Cronos Stock a Buy in October?

On October 28, Cronos (CRON) closed at 11.39 Canadian dollars on the TSE (Toronto Stock Exchange). This implies a decline of 3.96% since the beginning of the month. The company was trading at a 34.47% premium to its 52-week low of 8.47 Canadian dollars. Cronos was also trading at a discount of 65.43% from its 52-week high of 32.95 Canadian dollars.

Cronos closed at $8.75 on the NASDAQ, 2.34% lower since October 1. The company was also trading at a premium of 34.62% to its 52-week low of $6.50 and at a 65.14% discount to its 52-week high of $25.10.

Despite the overall bullish analyst sentiment for the stock, Cronos Group could not escape the gloom in the cannabis sector. Increased macroeconomic uncertainty due to the ongoing US-China trade war and the ongoing vaping crisis have negatively affected the still-nascent cannabis industry. Pricing pressures, the slower-than-anticipated retail rollout in Canada, and thriving black market sales have further pushed down cannabis stocks.

Against this backdrop, access to capital has become a major constraint for the cannabis industry. Further, the massive demand for energy for the indoor cultivation of cannabis is denting the industry’s image in the eyes of environmentalists.

As problems pile up, so does the downward pressure on prominent cannabis stocks. Based on the TSE closing price on October 28, Cronos Group was down by 27.08% YTD (year-to-date). Its peers Aurora Cannabis (ACB), Canopy Growth (CGC), and Aphria (APHA) are down by 32.3%, 28.11%, and 15.71%, respectively.

Stifel: Cronos Group is “New King in the North”

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The majority of analysts have a positive outlook for Cronos Group. However, they reduced the company’s consensus target price to reflect the conditions in the overall cannabis industry.

On October 18, Stifel analyst Andrew Carter went so far as to call the company the “New King in the North” in the cannabis industry. The analyst upgraded the stock from “hold” to “buy,” but he reduced the target price from 16.50 Canadian dollars to 14 Canadian dollars. Carter believes that the company’s recent share price drop offers an entry opportunity to investors.

Carter highlighted the cash total of 2.0 billion Canadian dollars on the company’s balance sheet as a major growth driver. This is especially important, as access to capital is a major restraining factor for the cannabis industry. Carter believes that this cash, coupled with partner Altria’s (MO) infrastructure, puts Cronos in a position to explore opportunities in this market, which is worth 200 billion Canadian dollars.

In December 2018, Cronos Group announced a strategic investment deal with Altria worth 2.4 billion Canadian dollars. In addition to capital, the deal helped bolster Cronos Group’s R&D (research and development), marketing, and distribution capabilities. Carter expects Cronos Group to leverage Altria’s distribution capabilities and penetrate further in the US CBD (cannabidiol) business. The Stifel analyst also expects the company to excel in the Canadian vapor segment.

On October 22, Piper Jaffray analyst Michael Lavery reiterated his confidence in Cronos Group. The analyst favors the stock due to its robust cash position and visibility on key strategic initiatives. However, Lavery cut its target price from $18 to $12.

Analysts’ estimates for Cronos Group

Hexo Inc.’s (HEXO) dismal pre-earnings announcement triggered analysts to reduce their sales and earnings estimates of several cannabis companies. This sentiment did not improve even after Aphria’s robust first-quarter performance. On October 16, BofA Merrill Lynch analyst Christopher Carey highlighted the need to reduce the consensus sales estimates of cannabis companies. He believes that a sustainable upside for cannabis stocks could ensue only after analysts revise their estimates downward to reflect the cannabis industry’s dynamics.

On October 29, Wall Street analysts expected Cronos to report revenue of 55.47 million Canadian dollars in fiscal 2019. This is approximately 4.63 million Canadian dollars lower than the consensus revenue estimate in September. The new revenue estimate represents revenue growth of 253.27% year-over-year.

Wall Street analysts also expect the company to report adjusted EBITDA of -60.36 million Canadian dollars in fiscal 2019. This represents a year-over-year increase in total losses of 286.95%.

Analysts’ recommendations

Cronos Group’s consensus target price has declined from 16.24 Canadian dollars to 15.85 Canadian dollars. The new estimate implies an upside potential of 39.16% based on the company’s closing price on October 28.

However, analysts maintain a consensus “hold” rating for the stock. Two analysts rated the company as a “strong buy,” and two more rated the company as a “buy.” These ratings are similar to those on October 24. However, seven analysts currently rate Cronos as a “hold,” compared to eight on October 24. One analyst maintained a “strong sell” rating for the company.

Comparing CRON’s valuation multiple with peers

On October 29, Cronos Group was trading at a forward-EV-to-sales multiple of 25.56x. The company also reported ROA (return on assets) and ROE (return on equity) of 36.00x and 30.81x, respectively.

On the same day, peers Aurora Cannabis, Canopy Growth, and Aphria traded at forward-EV-to-sales multiples of 9.82x, 13.31x, and 2.84x, respectively. Aurora Cannabis, Canopy Growth, and Aphria all have negative ROE metrics.

Should you consider buying Cronos Group stock?

Despite having significant resources, Cronos Group has continued with its asset-light marijuana cultivation strategy. Instead of direct ownership, the company has opted for the joint venture route to strengthen its manufacturing and distribution capabilities.

During its second-quarter earnings call, the company highlighted its strategy of working with contract farmers and suppliers. Cronos Group has contracted with third-party producers of cannabis and cannabis-derived products as well as with co-packers for co-manufacturing purposes. The relatively low capital utilization can enable the company to deploy its resources across segments and business functions in the cannabis industry.

Cronos Group has also deployed the joint venture strategy in international markets. The company is targeting the growing Australia market and has structured Cronos Australia, similar to the parent company. On October 25, the company announced the closing of the Cronos Australia IPO.

This entity was previously a 50/50 joint venture between Cronos Group and NewSouthern Capital Pty Ltd. Cronos Australia is also partnering with several third-party entities to target the Australia medical cannabis market. Since October 2017, Cronos Group has been in a strategic distribution partnership with G. Pohl-Boskamp to target the German medical cannabis market.

Cronos Group is also focusing on leveraging the Cannabis 2.0 opportunity. The company highlighted its edibles and vaporizer segments as key growth opportunities.

Despite these factors, headwinds in the cannabis sector have increased the volatility of Cronos Group’s share price. In our view, it is advisable for investors with an average risk appetite to wait until the company’s third-quarter earnings scheduled on November 12.

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