Cronos earnings: How much pot can it sell without Altria’s help

Cronos Group Inc.’s massive $1.8 billion cash windfall from Altria Group Inc.’s investment was the second large deal for the Canadian cannabis sector.

But it won’t matter for its fourth-quarter earnings — and there is little else to get excited about, says Jefferies analyst Owen Bennet.

“While historically a solid operator, at present we feel there is little to get really excited about other than the investment and large sum of money from Altria,” Bennett wrote in a note to clients in February. “We also question when Altria value creation will begin to [materialize], especially as there appears little near-term appetite to put the Altria money to work. Against this backdrop we think the market has gotten ahead of itself.”

Instead, like rival pot producers Tilray Inc. and Canopy Growth Corp., it remains an open question as to exactly how much recreational marijuana Cronos is capable of selling. In the third quarter, Cronos CRON, -5.36%CRON, -4.48% said a “major" part of its $3.76 million in revenue was from recreational product shipped to wholesalers in September, as it geared up for legalization.

But it did not disclose exactly how much revenue came from the recreational market, like many of its rivals — leaving analysts to speculate.

If there is anything to be gleaned from what major rivals have reported thus far it is this: Cronos’ costs are likely rising, which will in turn deepen losses. Cronos too is likely struggling with processing and packaging cannabis, which is one of the reasons Hexo Corp. HEXO, -7.07%HEXO, -3.87% said unprocessed marijuana inventory is vastly greater than the amount of pot available for sale. Like its rivals, it’s worth keeping a close eye on how much Cronos can fetch for every gram of weed it actually does get out the door.

Here is what to expect

Earnings: Analysts polled by FactSet expect Cronos to report fourth-quarter losses of C$0.02 ($0.01).

Revenue: Wall Street expects Cronos to bank revenue of C$10.4 million ($7.8 million). FactSet does not have enough estimates to form a reliable consensus for the price per gram of cannabis, or how much pot Cronos Group will sell. For the third quarter, which included several weeks of recreational cannabis sales in Canada, Cronos said it sold a significant amount but did not disclose the precise number.

Stock movement: Cronos stock has nearly doubled in the past three months, after Altria announced its stake in the company. The S&P 500 index SPX, -1.46% gained 16% in the same period, as the ETFMG Alternative Harvest ETF MJ, -4.16% rose 59% and Horizons Marijuana Life Sciences Index ETF HMMJ, -2.91% rose 67%.

Of the 11 sell side analysts that cover Cronos, three have the equivalent of a buy rating, five rate it a hold and three have a sell on the name. The average price target is $27.64, which represents an average upside of 35% from Thursday’s close.

Everything else: The Altria deal closed March 8, so it will not show up in the Toronto-based company’s financial statements until the first quarter — leaving executives the chance to give investors an update on any progress the two companies have made.

According to the terms of the deal, Altria has agreed to give Cronos C$2.4 billion and will receive warrants that, if exercised, would grant Altria an additional $1.4 billion and a majority stake in Cronos. The initial investment gives Altria 45% of the pot producer.

Beyond the cash Cronos gets to spend, the Marlbroro maker’s billions also propelled the small cannabis producer into a prominent position among its rival licensed cannabis producers in Canada. While cannabis producers of all sizes are trying to secure deals with big pharmaceutical brands, beverage giants and tobacco companies, only three have succeeded: Canopy Growth Corp., Tilray Inc. through partnerships and Cronos.

Bennett initiated coverage last month and said that while there are several positives in the Altria deal — the amount of cash means it will be “fully committed” to Cronos’ success — he cautioned investors that nicotine vape technology, which Altria knows quite a bit about, is different than cannabis. And while Altria has regulatory heft with the U.S. Food and Drug Administration, hemp and cannabidiol, or CBD, a compound found in marijuana some say has no psychoactive effects, is the path in the short run. Cronos has no hemp or CBD assets in the U.S.

Bennett wrote that in Canada under the recreational regime, Cronos is not as well positioned as some of its peers such as Canopy Growth CGC, -2.76%WEED, -1.50% or Aurora Cannabis ACB, -6.35%ACB, -5.16%

“Flower capacity could be limiting, its main [recreational] brand has a questionable target audience in our view, early consumer reviews of said brand do not stand out, and little infrastructure appears to be in place for the derivative market, even with the Altria support (unclear extraction capacity, unclear production facilities, and unclear as to near term differentiating [intellectual property] or licenses),” he wrote.

Bennett said Cronos is better positioned internationally but still lags behind the likes of Canopy, Aurora and Tilray TLRY, -4.68% To compete, Cronos needs more intellectual property and clinical trials —building on one it has conducted in Israel to date.

Bennett has a $17 price target and the equivalent of a sell on the name.

Altria’s investment in Cronos may be the largest in a Canadian cannabis producer, but it is not the first. According to GMP Securities analyst Martin Landry, that title likely goes to Alliance One International.

In early 2018, Alliance One, through a subsidiary bought Island Garden Inc. and Golden Pharm Inc. The details of both transactions were not disclosed.

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