Why Cronos Has Too Many Red Flags That Should Scare Investors Away

Given that competitors like Aurora Cannabis (NYSE:ACB) reported poor quarterly results, too, the sector is risky at the moment. Cautious investors may …

2020 is not proving very kind for Cronos (NYSE:CRON). The stock is down around by over 30% as the bubble in cannabis stock peaked and faded by March 2019. Back then Cronos Group stock traded at over $20. Altria’s (NYSE:MO) $1.8 billion investment in Cronos on Dec. 7, 2018, set off the bubble.

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Today, Cronos has vastly worse prospects than anyone imagined. As shares head toward its 52-week low, why should investors consider investing in the company at all?

Cronos Group Stock Lacks Positive Catalyst

In the second quarter, Cronos reported revenue growth by 29% to $9.88 million. And despite that, its gross margin of negative 30% is a change in the wrong direction. Last year, gross margins were 53%. Still, the revenue of under $10 million for a company with a market capitalization of nearly $2 billion (a price-to-sales ratio of around 55 times) cannot support the stock price. Since August, shares collapsed from over $7.00 to $5.50. Its short float is now around 27%. As its prospects worsen, bears will profit.

The $1.1 billion in cash and cash equivalents may set a floor on the value of Cronos. Still, the cannabis firm is burning money every quarter. Without profits in the foreseeable future, the stock lacks a positive catalyst that will send shares higher.

Related Investments

Multi-State Operators in the United States offer investors a better path for cannabis investing. For example, Trulieve Cannabis (OTCMKTS:TCNNF) continued its organic growth in Florida. It opened its latest Florida dispensary at Fort Myers on Sept. 22. Curaleaf Holdings (OTCMKTS:CURLF) opened its second dispensary in Florida. Curaleaf is a vertically integrated cannabis operator in the U.S. The firm believes that the addressable market for legal U.S. cannabis is $33.9 billion by 2025.

Potential Catalysts

Cronos has very feel potential catalysts in the near-term. Still, its cannabis extracts growth shows promise. In Q2, sales rose 25% to $1.92 million. Conversely, cannabis flower sales fell by 7%. So, if management reverses the sales decline, the stock may stop falling.

On its conference call, Chief Executive officer Mike Gorenstein pointed to Israel as an exciting market. He said, “Israel is an exciting market. And while we did originally think of it as something that we be used as an export hub, we have been and continue to be pleasantly surprised by the rapid growth in the medical market.”

Despite the strong prospects, Israel has a smaller population than Canada. But if the company has a model to compete effectively on cost and price, Israel is a prospective market. For now, Cronos must focus on the Canadian market. It needs to spend Altria’s money to advertise its business and strengthen its product uniqueness through strategic research and development spending.

Significant capital expenditures on infrastructure will drag on results in the near-term. After it has its commercial fermentation infrastructure ready, it may ramp up production. Initial costs and operating margins are unfavorable. But as Cronos builds out its downstream processing, investors will have to watch for revenue growth.

Price Target and Your Takeaway

Wall Street analysts did not issue an updated rating on Cronos stock in almost a month. The average price target is $6.38, according to Tipranks. Given that competitors like Aurora Cannabis (NYSE:ACB) reported poor quarterly results, too, the sector is risky at the moment.

Cautious investors may want to wait until tax-loss selling ends before speculating on cannabis firms. Just as the 3D-printing bubble collapsed more than five years ago, the cannabis sector is in the early phases of the same drop. Disciplined investors should invest in a basket of stocks in the sector. If it turns out that Altria’s management influence on Cronos yields results, then Cronos is attractive from here.

Anyone else who is afraid of losing more in this sector should stay away from Cronos for now.

Disclosure: On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article.