Should Cronos Group Scale Up Its U.S. Business?

Cronos Group (NASDAQ:CRON) had a relatively solid 2018, driven by the legalization of recreational marijuana in its home market, Canada, and a $1.8 billion investment from tobacco major Altria group. While Cronos has been focusing its retail efforts on Canada as well as international markets such as Germany, Israel, and Australia, where its medical marijuana products are gaining traction, the U.S. could potentially be a significantly larger market for the company in the long run. In this note, we take a look at what’s driving the cannabis market in the U.S. and how Cronos could potentially scale up its U.S. operations in the long run, subject to regulations.

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The U.S. Marijuana Market

As of November 2018, 32 U.S. States had laws allowing the use of medical marijuana, while 10 states (namely Washington, Oregon, Nevada, California, Alaska, Colorado, Michigan, Vermont, Maine, and Massachusetts) allowed the use of the marijuana for recreational purposes. Other states including New Jersey have been closely considering the legalization of recreational marijuana. Sales of medical and recreational marijuana in the U.S. are projected to climb to roughly $22 billion by the year 2022, per the 2018 edition of the Marijuana Business Factbook, up from levels of between $5.8 billion and $6.6 billion in 2017. While much of the growth in the market will hinge on regulatory developments, the increasing interest from major corporates in the tobacco and alcoholic beverage space could also drive the industry. Overall, it’s safe to assume that the U.S. market for cannabis will be significantly larger than the Canadian market in the long term.

The U.S. also took some steps towards the legalization of hemp – a variety of cannabis that does not produce the psychoactive component of pot – after it was removed from the controlled substance list post the passage of the 2018 farm bill. Hemp-derived cannabidiols were also legalized. Cannabidiol, or CBD, is a popular extract used in beverages and health products. Per New Frontier Data, the hemp-derived CBD market will grow from a $390 million in 2018 to a $1.3 billion market by 2022.

Cronos Could Leverage Altria Deal

While Cronos is still in the process of scaling up its overall business (total revenues stood at just $3.8 million in Q3’18), the company will likely wait until marijuana is legalized at a Federal level in the U.S. before it moves into the mainstream market. However, it’s possible that the company could make a play in the hemp space, like its Canadian rival Canopy, which was recently granted a license by New York to process and produce hemp. Cronos’ partnership with tobacco major Altria, which is the producer of Marlboro cigarettes, could also help the company if it decides to scale up in the U.S. Altria has an extensive distribution reach, as well as significant experience on the regulatory front. Cronos could also use the sizable cash infusion from the Altria deal to double down on the construction of greenhouses and processing facilities.  While annualized capacity stood at just about 6,650 kilograms as of Q3, the company is in the process of adding about 110,000 kilograms of capacity in the near term.

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