Don’t Buy Cronos Group Stock Until You See This

Marijuana companies are popular for one obvious reason: The market for marijuana is one the quickest growing markets in the world, sporting a compound annual growth rate (CAGR) of 28.02% between 2020 and 2025. In recent years, popular Canadian pot companies have started to capitalize on the U.S. cannabis market, which is expected to grow at its own CAGR of 17% until 2025, according to New Frontier Data. Although marijuana is still a…

Schedule 1 drug under U.S. federal law, which is defined as a drug, substance, or chemical with no currently accepted medical use and a high potential for abuse, Canadian companies are hoping to expand consumer bases in U.S. state markets where marijuana is legal.

Toronto-based Cronos Group (NASDAQ:CRON) is one company extending its reach. Its deal with the maker of Marlboro and Black & Mild brands, Altria Group (NYSE:MO), fascinated investors last year. But is Cronos reaping real benefits from the deal? There are three things that investors should be aware of before buying this stock, which are inhibiting Cronos’ growth.

Revenue is overshadowed by costs

Revenue for Canadian marijuana companies took a major hit last year after regulatory holdups caused delays in the openings of legal stores. This caused consumers to turn to the black market, which offers cannabis products at cheaper prices. However, this year, the pandemic caused consumers to purchase pot like any other consumer staple product — often and at regular, consistent prices. Revenues for U.S. cannabis companies have skyrocketed, and states including Colorado and California have seen record monthly revenues for legal cannabis sales. No doubt, Canadian companies have also seen a surge in sales amid the pandemic, but their growth is comparably modest, in part because the pandemic did its part in delaying legal store openings in 2020.

Surprisingly, Cronos, which boasts a market cap of $1.8 billion, higher than Canadian peer Aphria‘s (NASDAQ:APHA) cap of $1.3 billion, saw mellow revenue growth this year. But for the full fiscal year 2020, Aphria saw a stunning jump of 129% year over year to 543.3 million Canadian dollars. Meanwhile, Cronos only earned net revenue of $8.4 million in the first quarter and $9.9 million in the second quarter of fiscal 2020, bringing the total to $18.3 million for the first six months (ended June 30).

So Cronos is still growing revenue, including in its recent second quarter, but why is there such a drastic difference in growth from its Canadian cousin? It could because Aphria has a wider network, offering a range of medical and recreational cannabis products in Germany, Italy, Malta, Colombia, and Argentina. The company stated in its management, discussion, and analysis report that it maintains supply agreements for recreational cannabis with all Canadian provinces and the Yukon Territory, which allows it access to 99.8% of Canadians. Despite its international reach, Aphria’s focus is still on its core Canadian market, which drives revenue growth.

In addition to dragging revenues, Cronos’ costs surged in Q2 driven by higher selling, general, and administrative (SG&A) and research and development (R&D) expenses. The jump in operating expenses led to a rise in adjusted operating loss to $31 million, up $14 million from the year-ago period. Management said that an increase in the workforce to support the company’s growth strategy pushed the expenses higher, but its revenue numbers don’t reflect that growth. Cronos also had to reinstate items in the first three quarters of fiscal 2019, which cut off $7.6 million from its revenue for two of the quarters. Readjustments like these make investors skeptical.

Hopes for the U.S. vape market are fading

When vaporizers first hit the market in the U.S., demand was high. But things took an ugly turn when news on the dangers of vaping hit the market in 2018. The Centers for Disease Control and Prevention (CDC) identified illicit market vape products that contained vitamin E acetate, which caused a new disease called “e-cigarette or vaping product use-associated lung injury,” or EVALI. As of Feb. 18, 2,807 hospitalized EVALI cases or deaths had been reported to the CDC from all 50 states. Now, as COVID-19 sweeps across the country, consumer uncertainty about vape products and their effects coupled with the coronavirus, which can affect the lungs, has heightened. This dynamic spells trouble for Cronos’ business through its new partner, Altria.

Though many cannabis companies try to ensure that their legal products are of high quality, the effect on the market is… 

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