You Can Do So Much Better in the Pot Sector Than Cronos Stock

Stocks to sell

Pot stocks have crumbled, and Cronos Group (NASDAQ:CRON) has been one of the victims of the sell-off. CRON stock more than doubled from early August levels. But in the past 11 sessions, Cronos stock has dropped about 40%.

The catalyst seems to be what Luke Lango presciently predicted would be a “sell the news” event: the official legalization of marijuana on Oct. 17. With promise now reality and a nervous broad market perhaps adding some pressure, pot stocks have fallen across the board.

For the group as a whole, more downside seems likely. As I wrote about Cronos peer Canopy Growth (NYSE:CGC) last month, there are real echoes of the dot-com bubble in pot stocks at the moment. Marijuana sales are going to rise. But that alone doesn’t justify the enormous valuations in the industry, including the multiples assigned to Cronos stock.

And even if pot stocks do bounce from current levels, CRON hardly looks like the best player in the space. All told, at best there seem like easier ways to make money than Cronos stock.

Cronos Stock and the Marijuana Space

Marijuana stocks admittedly are cheaper than they were two weeks ago. And there’s been a nice bounce on Tuesday, with CRON stock up 6.5% as of this writing. If only from a trading standpoint, there is a near-term case for more upside.

To be sure, the sector remains expensive by most traditional valuation methods. But it’s also a group, particularly for those with exposure to the Canadian market, facing potentially exponential growth in the near term.

And after the roller-coaster of the past two-plus months, Cronos stock in particular isn’t that much more expensive than it was this summer.

The stock sits modestly above $7 at the moment; it’s traded above those levels multiple times this year. In fact, CRON stock actually is down 12% so far in 2018. Perhaps more interestingly, the stock trades only about 20% above where it did in early August, when Constellation Brands (NYSE:STZ,STZ.B) made the game-changing $4 billion investment in Canopy Growth.

Again, the fundamentals look ludicrous. Cronos stock is valued at about $1.55 billion (note that market cap data from most public sources underestimates the fully diluted share count) on the back of $7 million in trailing twelve-month revenue. But those sales are going to rise quickly over the next few years.

And trying to accurately model CRON stock for either bulls or bears is a classic case of the “garbage in, garbage out” problem. It’s the inputs that drive the model and those inputs are enormously variable. Can any investor confidently project 2022 revenue? Of course not. Is 30x 2021 sales appropriate for Cronos stock? 20x? 5x?

Pot stocks are going to be a “feel” space for some time to come until the numbers become big enough to make reasonably accurate fundamental projections.

Is CRON Stock the Pot Play?

We do know that over the next twelve months, Cronos stock is highly unlikely to move higher if pot stocks continue to fall. So there are two questions when it comes to buying CRON stock. First, are pot stocks going to rise? Secondly, if they do, will CRON be the best play?

Again, I’m not convinced the group is going to gain over the next 6-12 months. Certainly, the market will see some bounces over that stretch. But with many marijuana plays at 100x+ revenue, fundamentally there’s still plenty of room for a pullback. And with Canadian legalization now official, the group doesn’t have another notable catalyst on the horizon.

That said, history suggests pot stocks could move higher even from current levels. But I’m not convinced CRON is the play in that scenario. I still think CGC makes the most sense, given the cash from Constellation and its retail business.

There’s a case for Tilray (NASDAQ:TLRY), particularly now that its bubble has popped. Scotts Miracle Gro (NYSE:SMG) is a mess, with its marijuana-focused subsidiary Hawthorne in disarray. But with SMG at a two-year low, there’s an interesting contrarian case there.

The case for Cronos seems weaker in large part because it’s difficult to make a succinct case. Cronos has a diversified business, with efforts not just in capacity but retail and IP (intellectual property). But it hardly seems even close to being a leader in any of those areas.

Again, it has $7 million in revenue, in total, across those businesses over the last 12 months. Many of the operations run through an unwieldy joint venture structure. Cronos is trying to do everything, it seems but even with 100% control, it’s tough to do everything well.

There’s a case for buying marijuana stocks here, even if I’m skeptical. But there are better plays that are cheaper and/or stronger, than CRON stock. And so I’d bet that Cronos stock has further to fall or that, at best, other stocks have more to gain.

As of this writing, Vince Martin has no positions in any securities mentioned.

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