Cronos Group: Strong Growth Is Only Beginning – Seeking Alpha

With each major player in the cannabis space that reports financial results detailing performance figures for the first few months of recreational cannabis legalization in Canada, we have seen explosive sales growth, continued net losses, and a slew of moves made by managements aimed at setting up their respective firms for creating value in the long run. Cronos Group (CRON) has been no exception to this, and while the company’s activity in recent months may not be as great as some of its peers like Aurora Cannabis (ACB) or Canopy Growth (CGC), the firm is making some nice progress and is slated to accelerate toward capturing market share in the months to come.

Strong sales growth shouldn’t be ignored

In its latest quarter, which ended on December 31st of last year, Cronos was the beneficiary of Canada’s decision to legalize cannabis for recreational purposes. On October 17th of last year, recreational sales became legal, so the quarter ending last year was the first period for which we could get some idea as to the upside potential that could be generated by the firms in this space. For Cronos, like many of its peers, the upside was impressive.

During the fourth quarter of its 2018 fiscal year, Cronos reported net sales of C$5.60 million. This represents an increase of nearly 248% over the C$1.61 million the firm generated the same quarter a year earlier. As a result of these strong sales to end the year, net revenue for the company’s entire 2018 fiscal year came in at C$15.70 million. This compares to the C$4.08 million seen in 2017. Even though sales grew significantly, the ramping up of operations, combined with the firm’s inability to capture sufficient economies of scale (a typical problem for early-stage growth firms), resulted in net operating cash outflows for 2018 of C$9.74 million. This is nearly double the C$5.55 million in cash outflows the company experienced a year earlier.

As it grows, the management team at Cronos appears dedicated to a three-pronged strategy. On one hand, the firm intends to continue investing in its medical cannabis business, PeaceNaturals, while on the recreational side, they have two primary sets of operations: COVE and Spinach. COVE is aimed at the premium adult-use market (a space I believe is the most important for many firms to aim for long-term), while Spinach is dedicated to the mainstream adult-use market (i.e. cannabis for the masses).



Source: Cronos Group

While segmented information is sparse, we do have some idea as to the sales mix generated by Cronos during the quarter. Of the 1,040kg of cannabis sold during the fourth quarter, 775kg fell under the dried cannabis category. Not only did volumes rise 134% from the 331kg sold the same quarter of 2017, but prices managed to expand a bit as well. During the quarter, dried cannabis sold for C$5.45 per gram. This was up nicely from the C$4.38 per gram seen in the fourth quarter of 2017. What this demonstrates, to me, is impressive pricing power by management. The absence of pricing power would be disturbing because it could indicate either a weak competitive position, the existence of a market that’s much smaller than what has been estimated by analysts, or a mix of the two. This does not appear to be the case.

The rest of the cannabis sold during the quarter was in the form of cannabis oil. Volumes during this time frame actually exploded higher to the tune of 1,372%, but average sales price per gram plummeted from C$8.17 last year to C$5.08 this year. It appears that this change in price had a lot to do with Cronos absorbing some of the hit caused by excise taxes for its customers, which is a similar problem to what Aurora experienced, but in a space that supposedly has such strong demand, I can’t help but to feel like this explanation is weak.

Management is taking the right steps to achieve growth

As of the time of this writing, Cronos has 355,500 square feet of capacity in operation. This will allow, according to management, for the annualized growth of 40,150kg. At the C$5.39 per gram sales price Cronos reported for the fourth quarter, this works out to sales of up to C$216.41 million, but the company is well on its way to produce more than this. In the image below, for instance, you can see that if we include projects in progress, except for its NatuEra facility that is still in the planning stages, total capacity will eventually expand by 77,000kg per annum to 117,150kg.



Source: Cronos Group

This is fantastic growth, but the fact of the matter is that this is probably only the start of the upside the company can generate over time if analysts are correct regarding this industry’s prospects. In addition to the C$32.63 million in cash on hand that Cronos reported for the end of its 2018 fiscal year, the company closed its C$2.4 billion investment from Altria (MO) earlier this year. Today, Altria owns 45% of the stock in Cronos, plus the company has the right, through warrants, to acquire another 10% for C$1.4 billion. This alone will allow the firm the ability to grow rapidly whenever and wherever it wants.

Cronos did close that investment, but it’s not the only cash-generating move the firm made recently. Earlier this month, the company sold the 19% stake it owned in Whistler to Aurora for Aurora stock, then valued at C$24.7 million. The company later sold that stock for C$25.6 million on the open market (though I wish, for the sake of shareholders, it would have held the stock to further capture the upside prospects of one of its competitors). If certain performance metrics are achieved, the company could receive additional stock valued at C$7.6 million, giving it an expected return on its investment worth 8.7 times its initial investment.

Takeaway

Right now, Cronos is proving to shareholders that, like other players in the space, it can and is capturing upside created by a change in Canada’s cannabis laws. As the industry grows further, spurred in large part by the legalization of edibles later this year, prospects will improve considerably for Cronos and its peers. Now with a war chest of cash on its hands, the firm will be capable of reaching just about anywhere and everywhere that it wants, and so long as management is mindful to not use that cash recklessly, the firm will be in a nice position to deliver value to its shareholders in the long run.

Crude Value Insights offers you an investing service and community focused on oil and natural gas. We focus on cash flow and the companies that generate it, leading to value and growth prospects with real potential.

Subscribers get to use a 50+ stock model account, in-depth cash flow analyses of E&P firms, and live chat discussion of the sector.

Sign up today for your two-week free trial and get a new lease on oil & gas!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Read More