Markets

Dumping Cronos Group Stock Is a Big Mistake

Ever since shares of Cronos Group (NASDAQ:) topped $24 twice between February and March of this year, the stock fell into a bearish pattern. Cronos stock drifted lower and lower and is now in the $11 range, 54% below its yearly high.

Amplify Seymour Cannabis ETF (NYSEARCA:CNBS) Has Advantages

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Remember Altria’s (NYSE:) $2.4 billion CAD investment for 45% of the company? With Altria about to be underwater in its investment while Cronos has all that cash in its balance sheet, what are the prospects for this cannabis firm?

Second-Quarter Results Exceed Expectations

Cronos reported second-quarter adjusted earnings per share of 22 cents (CAD) as revenue more than doubled to $10.24 million CAD. Both figures beat expectations by a wide margin.

But adjusted earnings before interest, taxes, debt and amortization was negative $17.77 million CAD. Looking into the reconciliation of measures, Cronos recorded a non-cash $263.9 million CAD in the revaluation of derivative liabilities. Interest expenses topped $12.5 million CAD. Accounting for the change in fair value of the financial derivative liabilities associated with Altria’s investment does not have an impact on the cash flow. But Cronos warned investors to expect more adjustments ahead:

Cronos continues to expect there may be significant reported earnings volatility primarily driven by these fair value quarterly adjustments related to the movements of Cronos Group stock price.

Cronos ended the quarter with $2.3 billion CAD in cash and short-term investments. It has plenty of resources available to scale the business and to evaluate external growth opportunities.

Upcoming Priorities for Cronos Group Stock

Cronos has a few key initiatives ahead. It needs an enterprise resource planning system to support its global growth ambitions. This will connect the company’s global operations and standardize its practices across geographies and operating units. The short-term investor will look at the ERP implementation as a cost to the bottom line. But once the system is in place, the company will be able to support the global rollout of any of its product launches.

Still, in its growth phase, Cronos will focus on hiring talented and experienced staff. Again, investors are looking at staff growth as adding to costs, which hurts short-term results. And because cannabis stocks are out of favor, Cronos stock will perform poorly as it continues reporting losses each quarter. Tilray’s (NASDAQ:) 371% revenue growth but another quarterly loss is testing the patience of its investors. CannTrust Holdings (NYSE:) is set to become a penny stock after Health Canada caught the company producing cannabis illegally.

Revenue Growth Opportunity

Cronos will continue accelerating revenue growth from here. Driving its growth is the launch of , which will give it more production capacity. It is forming procurement deals with a third-party supplier and adding to its inventories. This is happening ahead of its derivative launch in the fourth quarter. Management acknowledged that Health Canada delayed the launch, which creates uncertainties for investors.

The offers plenty of upside growth potential but regulations are not yet clear enough to estimate the market potential. Cronos is waiting for clarity on the regulations around edible and topical products. To estimate it conservatively, Cronos thinks a launch in the late fourth quarter or at the start of the first quarter is possible. Bullish cannabis investors may expect strong initial demand when these derivative products come online.

Higher Costs Ahead

As I mentioned earlier, a higher headcount will add to operating costs but the company’s investment behind research and development will secure Cronos’ future growth. Marketing and advertising for CBD-based products in the U.S. have more flexibility. But the company still has opportunities for marketing in Canada despite the tougher regulations. In the near-term, such advertising efforts will add positively to building the Cronos brand.

My Takeaway on CRON Stock

Based on seven analysts covering Cronos stock, the average 12-month target price is . This is 95% above the recent $11.54 closing price. Investors who want to build their own fair value model may use a 5-year Discounted Cash Flow Revenue Exit model. One may assume strong revenue growth in that period. Even with a high discount rate, the fair value on the stock is higher than where Cronos stock is at today.

Should regulatory risks dissipate and the Canadian government allow derivatives and vaporizer products to launch, Cronos stock will rebound. And for Altria, its investment will pay off handsomely.

As of this writing, Chris Lau did not hold any of the aforementioned securities. 

The post appeared first on InvestorPlace.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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