What Will Drive The Growth For Cannabis Stock Cronos Group

Canadian cannabis stock Cronos Group (NASDAQ: CRON) (TOR: CRON.TO) has had a relatively mixed performance over the last few months, with its stock falling from over CAD 11 in early January to levels of about CAD 8.50 currently, due to relatively disappointing Q1 results and likely some profit booking, after the stock soared by 5x last year. While marijuana stocks, in general, face many risks as the organized market for marijuana is still in its infancy, there is significant scope for earnings growth in the industry. Below, we take a look at some of the trends that could drive the performance of Cronos Group and the broader Canadian marijuana industry going forward.

View our interactive dashboard What’s Driving Cronos Group’s Valuation which allows users to modify the company’s forward revenues and multiple to arrive at a valuation estimate for the company. We are valuing Cronos group at about CAD 9 per share, or CAD 1.6 billion, which is roughly in line with the market price.

Canada’s Legalization Of Recreational Marijuana

Canada will become the first G7 nation to legalize the use of marijuana for recreational purposes by adult consumers. This revolutionary law is anticipated to open up a new and lucrative market for cannabis companies in the country. According to market assessment, the sales of Canadian marijuana could go up by over $4 billion in the first year of its legalization. To prepare for the legalization Cronos is expanding its capacity (see below), while improving its retail footprint via a joint venture with the U.S-based company, MedMen, which will help it develop branded products and open stores across Canada for the sale of recreational marijuana. MedMen is the largest cannabis retail chain in California and the company’s retail expertise could be valuable to Cronos as it addresses new customer groups.

Scaling Up Manufacturing Capacity 

Cronos is looking to significantly ramp up its production capacity. While the company only had about 6,650 kg of capacity at the end of last year, it has estimated that its annual production capacity will exceed 47,000 kg by early 2019. To reach these levels, Cronos is scaling up its Peace Naturals indoor facility, while building a greenhouse in Israel and another indoor facility in Australia via a joint venture. The company is also creating a new oil extraction lab at its Peace Naturals facilities, which should allow it to create new cannabis capsules, tinctures, and ointments. Oils are typically more lucrative compared to dried cannabis. About 9% of the company’s total Q1 sales came from cannabis oils up from zero in the year-ago period.

Opportunities In Export Markets

Unlike the United States, Canada allows for the import and export of cannabis, giving Canadian cannabis companies a significant advantage over their U.S counterparts. This could give Cronos group significant opportunity to expand its operations globally. For instance, the company has inked a 5-year exclusive distribution agreement with G.Pohl-Boskamp, which will allow it to distribute its product to over 12,000 pharmacies in Germany, which is currently the largest cannabis market in the world.  The broader European market is also showing strong potential for Medical marijuana and this could also help Cronos, as the market is likely to favor cannabis oils.

Improving Funding

The cannabis industry has traditionally faced hurdles with raising funding, due to potential legal risks related to the industry. However, with the legalization of recreational marijuana, major Canadian banks such as the Bank of Montreal (BMO) and Canadian Imperial Bank of Commerce are getting directly involved in financing. The greater transparency and the additional capital that comes from the broader banking system could help to drive growth for these companies. For instance, BMO was an underwriter for a CAD 100 million equity raise that Cronos closed this year.  Being legal will allow these companies to do more — though they may still face many regulatory hurdles — similar to tobacco companies, such as Philip Morris.